SA better off than February, but problems of decay remain

It will have been just more than 100 days after the formation of the government of national unity (GNU) when finance minister Enoch Godongwana delivers this year’s medium-term budget policy statement on Wednesday.

The speech will be delivered under a different macroeconomic backdrop than was the case during the budget in February.

At the beginning of this year, South Africa was facing fiscal slippage — a potential catastrophe that was avoided when the minister, in his February budget speech, announced that the government would dip into the gold and foreign exchange currency reserves account.

At the time the country was in full political swing ahead of the national general elections, inflation was still above 5% and the currency well above R19/$. As a result of the uncertain political landscape, precarious fiscal position and an uncertain inflation trajectory, bond yields were trading closer to 12%. This presented the minister with a huge headache in terms of how to afford the elevated borrowing costs while funding the government’s responsibilities and still committing to fiscal consolidation.

Comparatively speaking, we are in a much more stable environment where central banks are cutting rates, falling commodity prices induced by lacklustre demand from China, a stronger currency, compressed bond yields, falling inflation as well as a dangerous geopolitical environment in the Middle East and Ukraine.

Elections were held at the end of May, resulting in no outright winner but a political settlement known as the GNU. The positive political outcome, falling inflation and lower interest rates have restored business and investor confidence, resulting in the rerating of South African bond yields, a stronger currency as well as a rerating in South Africa’s risk premium measured by the 10-year credit default swap spreads (279 vs 358). Eskom recently celebrated surpassing 200 days without electricity disruptions and this has allowed businesses to operate uninterrupted and is contributing to the restoration of confidence.

However, South Africa still has major challenges which are constraining growth: failing infrastructure, freight and logistical problems, bankrupt municipalities and, recently, water shortages.

With all this in consideration, there are a few announcements we can confidently expect from the minister when he delivers the medium-term budget.

First, debt reduction. Almost 90% of South Africa’s debt is denominated in local currency and with the recent strength in the local currency, the foreign currency-denominated portion when valued in rand will have declined. Compression in bond yields has reduced debt service costs for the government and the narrowing in credit default swap spreads will allow it to borrow cheaply. This will allow the minister to announce a narrower fiscal deficit and an earlier peak than was projected in the February budget.

In September, the National Treasury issued two new nominal bonds, with eight year and 14 year, respective, maturities. We do not expect a further funding announcement in the statement and there may even be a reduction in bond issuances. Possibly, the two new bonds will be included in the All-Bond Index in early 2025 and the effect of this will be to reduce the weighted duration and yield to maturity of the index.

We anticipate the minister may announce a review of the private-public partnership framework and introduce sector-specific regulations. These will target the energy, water, logistics and infrastructure sectors. We believe that fixed investments will drive structural growth and lift our growth trajectory.

South Africa has 257 municipalities and 169 of these are in financial distress. They owe Eskom about R78bn in electricity debt and have struggled to collect revenue. Municipalities spend only about 70% of their capex budget due to a lack of skilled personnel. There may be a sigh of relief if the minister announces some form of debt repose to these municipalities to help improve their financial health.

President Cyril Ramaphosa in this year’s state of the nation address announced the extension of the social relief of distress (SRD) grant by another year to March 31 2025. The minister may announce allocations to extend the SRDs beyond March 2025.

The general sentiment is optimistic, and we expect the minister to deliver a healthier prognosis of government finances given the improved outlook for South Africa’s growth trajectory. While we do share in the minister’s hopefulness, we believe that growth in the medium term may be curtailed by the logistical and infrastructural backlogs, proposed electricity tariffs, heightened geopolitical tensions and reduced consumption demand from China.

• Mabece is head of fixed income at Melville Douglas, the boutique investment management company for the Standard Bank Group