Every year, that budget ensures that the media covers every corner of it. Most of them are questions along the lines of, “What does the budget mean for taxpayers, the economy, and markets?”
Increasingly, this question should be asked in reverse. How does the state of the economy and bond markets affect the budget?
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Read: #Budget2024 in a nutshell: No major tax increases
That doesn't mean the budget won't have an impact on the bond market. Obviously so, since it determines the scale of government borrowing, and hence the supply of bonds.
Budgets also affect the economy. In the end, the government will spend R2.3 trillion next year. Spending levels have increased significantly over the past 12 years. But while in theory all this spending should support economic activity, as the budget points out, real GDP growth has averaged just 0.8% since 2012.
not multiplied
According to National Treasury's internal estimates, the so-called fiscal multiplier is less than one, meaning that each rand of government spending generates less than one rand of additional national income (GDP).
There are two main reasons for this. First, the quantity of spending has increased, but the quality has declined. It is often wasted or misallocated. For example, although education receives the most funding, it is clear that the country is not producing the skills it needs.
Another example is the hundreds of billions of dollars poured into Kushir and Medupi, both of which are brand new power plants but are not functioning properly.
Second, much of the increase in spending has been financed by borrowing. As the bond market's assessment of the government's creditworthiness deteriorates, borrowing costs not only for the government but also for the private sector have risen, putting a drag on economic activity. Rising borrowing costs mean governments' debt servicing burdens soar, crowding out spending in other areas such as infrastructure. Interest payments already exceed social subsidies. While the latter boosts consumption in the economy, the former's effect is less significant because 25% of bondholders are foreigners and most of the rest are domestic financial institutions.
Read: South Africa urgently needs a debt ceiling
In an election year, it is the rising interest burden brought about by rising government bond yields that is forcing the government to consolidate its fiscal health.
This brings to mind the famous words of James Carville, an advisor to former US President Bill Clinton. But now I want to get back into the bond market. You can blackmail everyone. ”
Deteriorating economic conditions and bond market skepticism are now having an impact.
Global government debt to GDP ratio and forecast
Let's put this into a global context. After the global financial crisis, government debt levels rose sharply as the public sector stepped in while the private sector retreated.
In many cases, however, the fiscal response was inadequate and austerity was introduced too quickly.
When the coronavirus hit, the government intervened again. In the United States in particular, the combination of falling tax revenues and large-scale economic stimulus has further increased the government debt-to-GDP ratio. Although the spike in inflation in 2022 has lowered these ratios somewhat (if there's one thing inflation does well, it's lower debt burdens), but as the graph above shows, debt levels are still the same as they were in 2019. It is higher than.
Are debt levels sustainable?
Are these debt levels sustainable, especially with rising interest rates over the past two years?
To put it very simply, if growth in nominal national income is higher than the government's borrowing costs (yields on government bonds), then it should be largely sustainable. Other factors come into play, of course, but fundamentally the simple relationship between income (nominal GDP) growth and bond yields determines whether a given debt level remains stable or continues to rise.
The chart below summarizes the difference between the year-on-year nominal growth rate (last quarter available) and the latest 10-year Treasury yield for some of the largest economies. Like tax revenues, most of the debt is nominal, so we focus on nominal growth rates.
Read/Listen: Treasury explains why fiscal stability is key to growth
By the way, this does not mean that countries can “inflate their debt”, as is often suggested. The experience since 2008 shows that inflation is not something that policymakers can create out of thin air, nor is it something that can be easily controlled once it arrives. What they can do is keep interest rates artificially low, also known as financial repression. However, keep in mind that while central banks set short-term interest rates, they have little direct control over long-term bond yields.
Difference between growth rates and interest rates in selected countries
In this large sample of countries, most countries have positive growth rate differentials, even though bond yields are higher than they were two years ago. Nominal growth will probably slow in the coming quarters in most countries. But Brazil, South Africa, and to some extent Mexico are already concerned about their fiscal positions. (No need to worry about oil-rich Norway.)
South Africa's key fiscal challenge is therefore to bring the growth rate and interest rate differential back into positive territory. As long as growth is low and borrowing costs are high, the only way to stabilize debt is to cut spending. Now let's talk about his 2024 budget speech.
Market-friendly budget
This can be summarized as a market-positive budget given the challenging circumstances, keeping in mind that a budget that is appropriate for the market is not necessarily the same as a budget that is appropriate for other segments of society.
First, the worsening of the fiscal deficit (the difference between expenditures and revenues) in fiscal 2023/24 was not as severe as widely feared. Although the consolidated deficit for the current fiscal year is smaller than the February 2023 forecast, it is expected to ultimately match the adjusted amount (4.9% of GDP) in the Medium-Term Budget Policy Report (MTBPS) in November.
The budget deficit is then projected to decline steadily to 3.3% by 2026/27.
This is achieved through continued spending discipline. Non-interest spending growth is expected to be slower than inflation over the next three years, although the upward adjustment was made to account for higher wages for front-line workers. The R15-billion annual additional tax revenue indicated in the MTBPS will be achieved by not adjusting the tax amount for inflation. Although this is a secret tax increase, it is still a tax increase. Fuel taxes are not adjusted for inflation, which gives motorists some peace of mind.
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No inflation relief for taxpayers
Incentives to encourage EV production in SA
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Excluding interest payments, the so-called primary balance is already in the black. In other words, non-interest expenses are already lower than income, and this surplus is expected to continue to increase further in the coming years. This will help stabilize debt ratios, but it should also be noted that the projected primary balance surplus of 1.8% in 2026/27 is ambitious and subject to several risks.
Fortunately, the pain of this integration is alleviated somewhat by unwieldy acronyms. Until now, few people had heard of GFECRA, the Reserve Bank's Gold and Foreign Exchange Emergency Reserve Account. But now it's the talk of the town.
GFECRA can help
GFECRA is effectively an unrealized gain or loss on South Africa's foreign exchange reserves. These profits or losses are held by the Reserve Bank but belong to the government. Unlike other countries, there is no regular transfer of profits from the central bank to the government.
The rapid depreciation of the rand from R6/$ in 2010 to almost R19/$ now means that the GFECRA has ballooned to around R500 billion.
Treasury will now use R150 billion of these proceeds to repay debt, reducing the government's total annual borrowing requirement from R553 billion in 2023/24 to R428 billion in 2026/27. be. This also means that the debt-to-GDP ratio is expected to stabilize at 75.3% in 2025/26, a lower and earlier peak than predicted in last year's medium-term plan.
Read: Treasury taps R500 billion emergency reserve account
A clear framework for GFECRA transfers will be formalized through legislation, which is important because the Reserve Bank's credibility and financial stability are at stake. However, it is highly unlikely that future remittances will be as large as R150 billion, so this should be seen as a temporary boost rather than a continuing source of funding.
Projection of total government debt to GDP ratio
Gain insight into the details of your budget forecast and the assumptions it's based on. However, the Ministry of Finance cannot be faulted for sticking to its promise of fiscal consolidation even in an election year. While populist budgetary policies are often seen in the run-up to elections in other developing countries, there was no hint of this in South Africa's 2024 budget speech.
Read: The story behind this year's budget
However, all these projections assume that there is continuity of policy over the three years covered by the budget framework and that the May 29 election does not disrupt plans. This is another reason why investors are in no hurry to draw firm conclusions about the fiscal trajectory.
economic forecast
And then there's the basic economic growth issue.
The economic forecast, on which all other budget figures are based, is for growth to steadily increase from a forecast of just 0.6% in real terms in 2023 to 1.3% this year and ultimately 1.8% in 2026. It shows that.
While this is certainly an improvement, it shows that the economy is still held back by some constraints.
Nominal growth is expected to average 6% over the next three years, but remains below prevailing market yields.
A surplus in the primary balance means that the government is taking more tax revenue out of the economy than it is giving back as expenditures, so fiscal policy does not support economic growth in the medium term.
Accelerating growth will require reforms that address serious bottlenecks in energy, logistics and other areas.
While the Budget focuses on these ongoing reforms, it also notes that regulatory changes are being considered to encourage and facilitate greater use of public-private partnerships. However, while the Ministry of Finance is in charge of macroeconomic policy and generally performs well, other inefficient government departments are not working, for example, issuing mining licenses more quickly or working permits.
In summary
The initial market reaction was positive as the results were surprisingly good (from a market perspective). However, these movements were quickly offset by changes in the pricing of the US interest rate cycle, reminding us that investing in South Africa has always been and always will be influenced by global trends.
The entire 2024 Budget Review is a 277-page document and it can be easy to get lost in a sea of numbers, ratios, projections and assumptions.
The bottom line is that South Africa needs faster economic growth to ensure long-term fiscal sustainability. Several reforms have been implemented to address major constraints on economic growth, but it will take time for them to bear fruit.
But in the meantime, South Africa cannot wait for faster growth to arrive as the government's interest bill balloons to excessive levels.
Therefore, the focus on fiscal consolidation is primarily through spending discipline (helped by the GFECRA windfall).
Rating reviews in the bond market (reducing yields relative to peer groups) and sovereign credit rating increases by Moody's and others will likely wait until there is evidence that these fiscal targets are actually being met and growth is expected. would have to. Intensified reforms are bearing fruit.
Nevertheless, a combination of prudent fiscal and monetary policy (a conservative central bank that sticks to its inflation target) continues to provide a strong anchor for bond market valuations.
Izak Odendaal is an investment strategist at Old Mutual Wealth.