Pre-budget Commentary: Arthur Kamp, chief economist Sanlam Investments

Budget 2024 is likely to spell out an all-too-familiar story. Despite years of attempted fiscal consolidation, the debt ratio continues to trend higher. But without breaching its funding constraints, we believe there is room for government to take some positive steps. Here’s what we hope the Minister of Finance will say on Wednesday.

The context: government’s debt dilemma

A main budget deficit for 2023/24 of around -5% of GDP is expected to be unveiled, comparing unfavourably with National Treasury’s initial projection made in February 2023 of -3.9% of GDP. Treasury is likely to continue mapping a path to lower budget deficits and stabilisation of the government’s gross loan debt ratio in around three to four years – although the debt trajectory may be lifted relative to the level of 77.7% of GDP in 2025/26 published in the November 2023 Medium Term Budget Policy Statement (MTBPS).

The debt ratio has moved from a low of 26% of GDP in 2008/09 to 74% of GDP at the end of Q3 2023. As a result, the government’s borrowing requirement (to fund the main budget deficit, redemptions and transfers to Eskom) is currently more than R550 billion a year.

Despite this, various factors are helping to hold the fiscal ship steady. Government debt has a long maturity structure, while most debt is issued in rands, which precludes a typical balance of payments crisis triggered by foreign exchange shortages. Also, as part of the funding mix, Treasury has been able to draw on its formerly sizeable cash balances, although these balances have been run down to the point where future use must be limited.

Still, in the absence of sufficient improvement in the primary budget balance (revenue less non-interest spending) to around 2.5% of GDP, the debt ratio seems set to continue trending higher. That would intensify funding pressures.

The problem for Treasury is that budget execution risk is high, particularly on the expenditure side, in an environment where persistent low growth is constraining revenue. This is a concern because history shows successful fiscal consolidations usually require expenditure restraint. However, SA’s socio-economic conditions preclude sharp cuts in services and critical functions, including health and education. Indeed, there is a strong argument for extending the social relief of distress grant in the long term, or replacing it with a similar grant. Even though the social wage is above 60% of non-interest spending, spending pressure is likely to be sustained since SA’s unemployment rate is likely to trend higher, unless growth lifts markedly.

In addition, even though there has been focus on improving the government’s budget deficit and debt ratios, the deterioration in the total public sector balance sheet, including state-owned companies (SOEs), has undone fiscal consolidation attempts. Additional transfers to SOEs are expected in the medium term, over and above the announced transfers related to the Eskom debt relief arrangement of R66.2 billion in 2024/25 and R110.2 billion in 2025/26 (which follows transfers of R78 billion to Eskom in the current fiscal year of 2023/24). The expected main budget deficit of -5% of GDP in 2023/24 excludes the transfers to Eskom, which amount to just over 1% of GDP.

How a good Budget looks

Against this backdrop, what would we like to see in the Budget?

Firstly, it is worth remembering that since it is difficult, if not impossible, to predict the future, investors pay attention to track records and intent. Currently, SA’s fiscal policy track record is off track. Top of our wish list is that the Minister of Finance provides an update on the expenditure review and progress on rationalising the public service. The November 2023 MTBPS indicated that where there was duplication or a lack of capacity, state entities could be merged or closed in the medium term.

There was talk of setting out fiscal rules, for example an anchor for spending or a target for the primary Budget balance. An announcement on the latter would go a long way towards demonstrating intent to stabilise the debt ratio, although there are likely to be different views on how much improvement in the primary budget balance is required to achieve this.

At the same time, to the extent that Treasury runs budget deficits to support ailing demand in the economy, these deficits must be skewed towards capital expenditure. This would help to protect government’s balance sheet (by increasing productive assets). In any event, capital expenditure has a markedly more positive impact on GDP than consumption expenditure. Meanwhile, Treasury must continue to enforce the conditions attached to transfers to SOEs, which are designed to stabilise them.

This line of thinking should permeate all fiscal decisions, including those related to tapping the Gold and Foreign Exchange Contingency Reserve Account (GFECRA) on the Reserve Bank’s balance sheet to help fund the government. This now seems likely to happen, if not in the immediate future, then in the medium term. The large surplus on this account (estimated at about R500 billion) arose due to unrealised revaluation gains on the bank’s gold and foreign exchange reserves, reflecting the marked depreciation of the rand in recent years.

Tapping this surplus is not straightforward, and rules will need to be written to ensure it is used prudently. It is also important to note that monetising the surplus will not be costless. The bank is likely to seek compensation from Treasury for the associated sterilisation costs. Alternatively, the foreign exchange reserves could be sold to “unlock” the unrealised gains. This seems unlikely, however, given the country’s low level of foreign exchange reserves against the backdrop of a sharp fall in net foreign capital inflows since 2015.

Note that only a portion of the GFECRA surplus is likely to be tapped over time. Any large, sustained appreciation of the rand would reduce the surplus materially.

We would like the government to announce that, if the GFECRA is tapped, the money will be used to pay back debt, rather than fund additional spending.

Finally, the announcement we are not looking forward to is the additional R15 billion in revenue-raising measures that Treasury has indicated would be required in 2024/25. A significant portion of this may be realised from increased personal income tax collection by, for example, not adjusting for bracket creep, in addition to the usual tax increases, such as excise duties. However, we cannot be certain what form it will take.

Overall, it is unreasonable to expect announcements in Budget 2024 that are immediate game-changers, at least not until economic reforms gain broader momentum to lift GDP growth. However, there is an opportunity to put in place some important building blocks, which hold the promise of changing the fiscal trajectory. Hopefully, these may be the first steps towards sovereign debt rating upgrades and lower borrowing costs over time.