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Jimmy Moyaha: Listen to SAfm Market Update on Moneyweb. I'm your host, Jimmy Moyaha. We will discuss the latest developments from the rating agency Fitch. They announced they had little confidence in the budget speech given by Finance Minister Enoch Godongwana last week. They flagged several concerns – and these concerns are shared by Food Asset Management.
I joined Linda Eades, Head of Investments at Food Asset Management, on the phone to discuss this. Good evening, Linda. Thank you very much for your time.
Let's start with the concerns raised by Fitch in its statement. I understand that they reviewed our ratings in January and kept the outlook stable. However, there were some concerns. I think following the speech that was made last week, they issued it again yesterday with some modifications to those concerns.
Linda Eades: Good evening, Jimmy, thank you for having me. Yes, they definitely did, and as you say, we certainly share some of those concerns.
They first accepted the credit rating as BB-, so we are still in junk.
And they said they think this budget is a little too optimistic in a number of ways.
First, let's talk about the earnings outlook. They believe the shortfall between government revenue and spending may actually be better than budget projections.
And second, they are concerned that the budget does not include further provisions for the expansion of state-owned enterprises. [SOE] Remedies. Of course, we saw in December that Transnet was given a government guarantee of R47 billion, and they actually think this could increase – and things like this.
They predict Transnet will need an additional R50 billion over the next two years.
And the last point they made, which we also share, is to take advantage of that unrealized gain. Gold and foreign exchange emergency reserve account [GFECRA] It's true that the amount you have to borrow has decreased, but it's basically just a waste of money. The underlying problems being caused, such as credit ratings, are not resolved.
Read: Treasury taps R500 billion emergency reserve account
These are things they outlined as being a bit worrying.
So, a reasonable budget, but is it very realistic?
Jimmy Moyaha: So let's dig into some of SOE's concerns. Let's start with that. Obviously, the revenue side and the optimism around that revenue won't get much attention until we start to see revenue recovery from SARS. He remembers talking to Edward Kieswetter from SARS about this. He said Sars would continue to work hard to recover as much money as possible, but it was difficult to commit to numbers.
But I would like to look at the SOE side. Before entering gold and foreign exchange contingency reserve accounts, [among] For state-owned enterprises, the main concern is clearly with Transnet, but also with Eskom. If I remember correctly, just before or in advance of the budget speech, Eskom's projected diesel budget for the year was almost maxed out. I think there were still three or four months left in the fiscal year. This means Eskom is spending over budget and someone will have to make up the shortfall.
This is also flagging from your point of view, that state-owned enterprises are being completely ignored, that Eskom, Japan Post Bank etc. are in dire need of support, and that one day it will come back to bite us. Is that what you're saying?
Linda Eades: Well, Jimmy, as you know, the main reasons why South Africa's economic growth is being held back are the problems with energy supply and obviously the aging infrastructure. Of course, this also includes railways and ports.
Of course, these issues need to be resolved. Unfortunately, however, simply providing SOE relief, and this is also the case for Eskom, does not seem to solve the underlying problem. So these are the things that Fitch looks at in terms of South Africa's potential.
Why it's important is that it provides some kind of measure of how the world views South Africa, both in terms of the risks of lending government money and the returns that investors seek in terms of investing in South Africa. Because it is set.
Of course, it needs to ensure that its spending is carried out effectively, which is not a very good track record for state-owned enterprises.
We need economic reform. Infrastructure issues need to be resolved. Those issues need to be resolved. Since 2012, South Africa's growth rate has averaged less than 1%, and the population has grown faster than that. So on a per capita basis, we are getting poorer.
Then the other thing that Fitch is looking at in terms of all of this is things like saying the government may need to take over another R50 billion of Transnet's R150 billion of debt. But why that matters is because government debt levels are already incredibly high.government [debt] The total amount is over R5 trillion, and the figure looks set to grow, making it difficult to rein in spending in an election year.
And of course, the interest rates we pay on government debt are actually eating into our budgets. This means that 21 cents of every rand collected by the government in revenue and taxes is used to pay interest on the national debt.
Companies like Fitch will actually be giving the world an indication of how high interest rates need to be to compensate the risks taken by those lending to the South African government.
And unfortunately, the South African government seems to have become an increasingly risky proposition over time.
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by becoming [spending] Really needs to be reined in. Government debt levels do need to be lowered and, importantly, the world needs to see us as a low-risk country to lend money to. That would lower the level of interest rates and free us up to spend in other more important areas of the economy. To encourage economic reform.
Jimmy Moyaha: Is it a good idea to use a gold and foreign exchange emergency reserve account if you are trying to become a country with less external risk in terms of foreign direct investment? Other countries do this all the time. We know it's being done, and it's not unusual for governments to undertake this, but is it wise for our country to take advantage of this? that Or were there alternatives we should have considered, such as cutting public sector wages or addressing the underlying fiscal problems? Is there anything else we can do other than join this account? Was it?
Linda Eades: Yes, Jimmy, absolutely. I think everything you mentioned is a problem for us. Public sector wages continue to rise. Of course, we've seen higher-than-inflation increases over the years, but that's unsustainable. But I think it was probably realistic for it to be pushed back significantly in an election year.
It's a short term fix. If they hadn't done that, I think the market would have reacted quite negatively.
But like I said, it's really only a short-term solution. It doesn't solve the fundamental problem of creating an environment that allows for growth. To pay down and reduce debt, the economy needs to grow sustainably.
One of the things we look at as investment managers is the debt-to-GDP ratio. In other words, it is the total amount of government debt relative to the country's total economic output, i.e. the total amount of all goods and services that South Africa produces. of GDP.
This ratio has increased from about 30% more than a decade ago to more than 70% today, and is expected to reach about 75%. By leveraging some of this unrealized gain, this amount has been reduced slightly, but this is significant.
However, Fitch and Food Asset Management believe that the debt-to-GDP ratio will start to rise again, perhaps worse than the Budget anticipates.
We think it could be over 80%. In that case, the economy would be in a very difficult situation in terms of producing enough goods and services to service the necessary debt sustainably.
These are important metrics to watch going forward.
Jimmy Moyaha: In her budget speech, Treasury Secretary Linda outlined medium-term growth projections for the next three years or so. The average is 1.6%. First of all, is it a realistic number based on your estimates and expectations? And secondly, if not, what is the realistic number?
Linda Eades: Again, we think this may be a little too optimistic. Of course, a lot depends on the global economy, but it could probably be closer to 1%. Again, we think our assumptions may be a little more optimistic than reality.
In particular, of course, we just need to solve these major problems, but unfortunately, in terms of actual implementation, state-owned enterprises and governments have not demonstrated the ability to do it quickly.
But expect to be surprised by the positive rather than the negative in that regard.
Jimmy Moyaha: We hope to always be pleasantly surprised, but we are also alive to the fact that we are dealing with many challenges.
Linda, before I leave you, I want to go over some rumors that we've been hearing around the central bank. This is a conversation that's been going on for years that I'd potentially like to explore. The inflation target range will be lowered from 3% to 6% and from 2% to 4%.
In the current economic climate, that would prove very difficult to do, and interest rates would remain high for a long time. Do you think we should do this, or do you think we can focus on economic growth, stimulus and job creation and deal with it later?
Linda Eades: Again, one of the things we're looking at is whether the government is likely to be able to bring inflation down to that level. We have clearly seen inflation decline slightly over time. Recently, it has been gradually increasing. Much of the inflation is clearly imported into our economy.
Unfortunately, one thing we don't have is economic growth that actually causes inflation, as opposed to, say, the United States. In the US, some of the core inflation is actually occurring because the economy has been more resilient than expected. . We won't really see a sustained decline in inflation unless we solve many of the problems we face.
So in terms of getting it down to low levels again, we would like to see inflation stay within its current range. Some of it is outside the control of financial authorities. We'll see that in how it plays out in practice.
Jimmy Moyaha: Well, we'll keep an eye on it and see how it all plays out. I hope we can have more positive conversations about these and other topics in the future. I also hope that we will see fiscal reforms that are desperately needed, not only to reassure foreign investors, but also to grow our economy.
Thank you so much, Linda. I'll leave it as is. That's Linda Eades, investment executive at Ford Asset Management, who joined me to review Fitch's latest announcement and voiced her concerns about the forecasts in last week's budget speech.
