Supplementary Budget Review & Inflation sinks to 3% in April 2020 under lockdown

Initial impressions

In our view, Treasury’s growth and inflation forecasts are realistic at an average of negative 0.4% and 3.9%, respectively, for the next four years
Budget deficit at 15.7% of gross domestic product (GDP) for FY20/21 came out at the higher end of the Bloomberg consensus range of between 10% and 15.9% è fiscal deficit is expected to be 4.2% wider on average in the medium-term expenditure framework (MTEF) between FY20/21 and FY22/23
Expansionary budget initially as real expenditure growth outstrips revenue growth - government expects cuts in expenditure in the remainder of the MTEF to narrow the deficit to 7.7% by FY22/23
Relative to the February 2020 national budget, revenue collection was revised lower by R716.7 billion in the MTEF è while expenditure was adjusted lower by a lesser R174.6 billion
Insufficient detail outlining concrete action on proposed structural reforms to enhance the recovery

Immediate market effect

Given updated views from treasury on the weekend, markets easily digested the news of a larger fiscal deficit with a sideways movement in the equity, fixed income and currency markets

Government debt expected to stabilise in FY23/24, but adjustments are necessary

Initial deterioration in SA’s government debt ratio is due to a R299 billion revenue shortfall (main budget) and an additional R43.2 billion allocation to expenditure in FY20/21
Gross debt ratio expected to rise to 86% in FY22/23 (previously 71.6%) - on average the debt ratio is expected to be 14.5% higher over the MTEF
Primary balance remains in deficit during the MTEF - it is expected to narrow to 2.3% by FY22/23 (previously 1.1%) from 9.7% in FY20/21 (previously 2.6%) è expected to print a surplus in FY23/24
Debt-service costs absorb 21c of every rand government collects relative to 9c in FY08/09 - interest bill expected to rise from 4.9% of GDP in FY20/21 to 5.4% of GDP in FY22/23 - the allocation to debt-servicing costs is similar in size to what government spends on health and is double the share being spent on capital assets
Measures to narrow the budget deficit and stabilise debt will be announced in the October 2020 medium-term budget policy statement (MTBPS)

Cost reductions, above efforts to reduce the wage bill, are required

Treasury has attempted to reopen the final year of the current wage agreement to achieve R37 billion in savings - the proposed savings of R55 billion in FY21/22 and R67 billion in FY22/23 are arguably
more crucial
Treasury claimed that failure to achieve R230 billion worth in savings (beyond the projected cuts to the civil servant wage bill) would result in even larger cuts to the wage bill or a reduction in spend in
other areas of the budget
Little detail was given on the current negotiations between government and the unions - raising concerns over whether government will successfully achieve a reduction in the wage bill of this size
Conditional grant transfers were scaled back and delayed where possible
Limited details were shared on the zero-based budgeting approach treasury is expected to adopt - ultimately this process could be time consuming and costly, but it should enhance transparency,
enforce accountability and allow for a phasing out of programmes that have little effect on service
delivery or economic performance

Income and other support to consumers

Government awarded temporary social grant top-ups (67.4% increase in child support grants and 13.4% increases in old age and disability grants) for six months
These social assistance interventions will apply until October 2020 è continued household vulnerability may pose a challenge to removing the top-up grants in our opinion
At mid-June 2020, the Unemployment Insurance Fund has disbursed R23 billion to more than 4.7 million employees
Banks have provided R30 billion of relief to customers
Awareness of damaging effect of further tax hikes to economic growth has warded off significant tax proposals - tax increases proposed are modest in our view
However, projected wage cuts of R160.2 billion in the MTEF imply lower spending ability particularly for middle-income earners

State-owned enterprises (SoEs) and municipal finances remain in disarray

The February 2020 national budget already included a R16 billion allocation to SA Airways – the additional R10 billion may only come through in the October budget, once the business rescue plan
has been finalised
Treasury to inject R3 billion in equity in the Land Bank while restructuring plans are being finalised - the institution plays a critical role in providing 29% of SA’s agricultural debt
Despite lockdown restrictions lowering revenues for Airports Company South Africa, Eskom and the South African National Roads Agency Limited, no other intra-year spending adjustments were
proposed for SoEs
Treasury noted SoE reform included rationalisation and equity partnerships
No adjustment was made to the R1.1 million taxi industry relief fund despite backlash
Metropolitan municipalities reported that revenue collected in April fell by 30% on average as a result of higher non-payment by customers è this places local governments deeper in financial stress

Infrastructure at the centre of the recovery plan

SA’s investment-to-GDP ratio tanked to 17.9% in 2019, which is the lowest since 2005
Treasury reiterated that infrastructure would feature strongly in SA’s economic recovery
Government showcased 280 projects (88 already considered to be bankable) at the Sustainable
Infrastructure Development Symposium held on 23 June 2020 which was attended by 681 delegates
At the symposium, it was announced that government is considering the introduction of green infrastructure bonds
The New Development Bank has registered a bond sale plan with the Johannesburg Stock Exchange and the first phase is expected to be completed within six to nine months

Financing the COVID-19 stimulus package and the gross borrowing requirement

Treasury is accessing US$7.0 billion from international finance institutions - this comprises a US$4.2 billion Rapid Financing Instrument from the International Monetary Fund, US$1 billion from the New Development Bank and US$50 million from the World Bank - no detail was given on how the remainder would be funded
Government revised its borrowing strategy to temporarily issue shorter-dated bonds with a weighted average time to maturity of seven to 10 years, compared to 15 years seen in the previous year è this
aims to manage the cost of debt and balances available market demand
To moderate its domestic borrowing, government will draw down sterilisation deposits by around R43 billion
The significant ramp up in projected debt and issuance will likely add to pressure for further sovereign rating downgrades

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INFLATION SINKS TO 3% IN APRIL 2020 UNDER LOCKDOWN

Highlights

Headline inflation dropped to 3% in April from 4.1% in March 2020 (published on 22 April 2020). This was broadly consistent with market expectations of 3.1%, as captured by Bloomberg.
The release date for April’s consumer price index (CPI) was delayed due to lockdown restrictions, limiting Statistics South Africa’s (Stats SA) fieldwork used to collect survey data.
In line with international best practice, Stats SA has used an imputed price methodology for items and services that were not available for sale during the lockdown. A quarter of the CPI weightings had to be calculated in this manner, while carry-forward prices were used for more than 40% of the basket items.
While this method is deemed to be economically meaningful, it should be noted that the inflation number for April 2020 was based off a significantly smaller sample and this affected the regional breakdown.
Stats SA is expected to publish May’s inflation number in the middle of July 2020, while two thirds of its fieldworkers were active to collect June’s prices, from when the normal methodology is expected to resume. The June number is likely to be released in July, closer in line to the original scheduled dates set prior to the lockdown.
In our view, decimated demand and lower international oil prices should cap the rise in price pressures, leaving room for the SA Reserve Bank (Sarb) to ease interest rates by a modest 50 basis points in 2020.