Grinding fiscal under-performance likely: Nomura

Minister of Finance Malusi Gigaba.

After the cabinet reshuffle in March, 25 October will be the first major outing for Finance Minister Gigaba and will remove much uncertainty surrounding his fiscal world view. We believe the broad fiscal headline narrative will not change: grinding under-performance, partly pushing out consolidation, expenditure contained but not meaningfully cut and debt and issuance levels grinding higher.

The big uncertainty will be over how much is pencilled in and how quickly there will be SOE support for SAA, Eskom and others, and the asset sales that will have to accompany this. We do not envisage a blow out in the Budget, but credibility will likely be tested if ‘anonymous’ revenue hikes are leaned on too much and growth and buoyancy forecasts are over-egged. We expect the deficit to move out by around 0.9pp of GDP for the current fiscal year, but the MTBPS may well see a slightly smaller number presented. There is unlikely to be any definitive blow on the ratings side, but is likely to push agencies further down the path towards cuts into 2018.

The Medium Term Budget Policy Statement (MTBPS) is fundamentally about setting out expenditure priorities for departments and lower tiers of government over a five-year period. However, it equally shows the choices made about revenue, revenue vs expenditure doing the heavy lifting on consolidation and at its most basic the Minister of Finance’s ‘fiscal ideology’.

Political backdrop

This is the fundamental issue at stake for Minister Gigaba and his ministerial team at the MTBPS – what is their fiscal world view? The answer is far from clear since his time in office from end-March, but his presentation of the MTBPS on 25 October will be his first real fiscal policy outing.

In this sense media coverage about state capture of the National Treasury is unhelpful in considering credit risk specifically on the MTBPS. What will be important for rating agencies and investors will be the following three specific issues:

·         Fiscal world view: We believe Minister Gigaba understands the need to keep the budget in check in the long run and not cause a crisis requiring the IMF (paralleling and supporting his Presidential ambitions in the long run). 

·         Political power: We believe Minister Gigaba has more political power to undertake difficult actions than previous Ministers Pravin Gordhan and Nhlanhla Nene did in terms of his relationship with the President – something that completely broke down for his predecessors. That said, the politically charged environment of an elective conference year, together with 2019 not being far away will mean his political space to operate (beyond the simple fiscal constraints themselves) will be less than ideal.

.          Fiscal workings: We stated at the time of the Budget last year that NT staff were highly effective at working with line departments in the form of a strategic battle. We believe this is still ongoing and staff may negotiate and make space within department budgets, though low hanging fruit are increasingly unavailable. We also believe more than the state capture narrative – it is more important to consider what shift in structural interactions has occurred between the Ministry of Finance and NT – ie the Ministry has become more remote from the staff in our view than it was in the past, when it was well integrated.

Ratings view

Moody’s and S&P will update their ratings on 24 November after the MTBPS, but will likely make some comments the evening of the MTBPS or shortly after. Fitch is expected to update its rating in November, but has made no announcement on the scheduled date, though this is less important as both its ratings are already in sub-investment grade, and also because they play less into indices.

We expect all agencies to take a dim view of debt levels grinding higher and movement away from consolidation, though we think there will be no dramatic news on this front. However, credibility will be an important issue especially on the forecast and any scepticism on anonymous revenue increases by the agencies. However, we think most ratings agencies’ focus will be on SOE issues, where there can be more details in terms of announcements with credit implications.

Our baseline is that Moody’s could put South Africa on credit watch in November, but the period after the elective conference before the Budget it is more likely to institute watch. We expect Moody’s to eventually lower its rating after the Budget. That said, the agency has continued to give the benefit of the doubt on fiscal, political and budget issues – more so than the other agencies – and this risks cuts later. We think there is a chance that S&P will lower its ratings in November because of SOE developments, but it will be difficult before the elective conference and it is more likely to move straight after a status quo candidate is elected in early January or else after the Budget next year with more conviction on that view than Moody’s.

That said, we expect all agencies to sound particularly gloomy in their updates in November.

Other specifics

The big focus beyond the fiscal position will be the SOEs. The dual context is increasingly tight supply of bank bilateral liquidity for SOEs and a drying up of commercial paper and bond market access at decent pricing on the one hand and continued loss making, political interference and new boards and management changes on the other. The 14-point plan stated that guarantee exposure would fall to SOEs, but the recent bailout for SAA has shown there is a strong implicit guarantee over all SOE debt, even if explicit guarantees are given out less.

Bailouts are required for SAA (equity), Eskom (cash bridging loan) and SABC (equity). SAA’s total package has already been announced by the NT as ZAR13bn, of which ZAR5.2bn has already been extended to cover non-rolled unguaranteed debt with a small additional working capital injection of ZAR1.3bn. However, the MTBPS will take place before the SAA AGM, and at the Budget in February and continually through the year there have been discussions about removing SAA Chairman Dudu Myeni, though she looks set to remain in post until next year at least. As such comments on SAA’s future need to be looked at carefully.

SABC requires a ‘small’ equity injection after continued losses accrued in recent years. There has been some confusion over the numbers however. Originally, we had assumed maybe ZAR1bn or so would be the maximum required for what is a small operation compared with other SOEs. Yet SABC has said it has been asked for ZAR3bn, which seems excessive.

Eskom requires another equity injection in the coming three years more to improve metrics (like for the previous one) than for actual working capital required. Such a move would seek to improve borrowing costs from a balance sheet that has stabilised, but at a very weak level. However, an equity injection announcement is likely to be put on the back burner at this time. Of more immediate importance will be a cash-bridging loan through fiscal Q4 (calendar Q1 2018) because Eskom looks set to be running cash reserves down rapidly as a result of such low tariff increases awarded this year (2.2%) and will be below its desired liquidity buffer through most of the year. Again the problem may be if the NT decides not to announce anything at the MTBPS and simply waits to announce something when it is occurring say well into December.

There are increasing concerns from the auditor general on PetroSA that made a ZAR1.4bn loss in the last fiscal year and looks increasingly unsteady. However, a recent Russian investment of USD400mn in joint oil and gas projects may remove the need for anything major to be done by the NT at this stage.

The other problem we have on the MTBPS is that the full record of contingent liabilities is not published, but would be much in demand from the ratings agencies and investors. However, the key details may well come out if there is another ‘fiscal risk statement’ in the MTBPS like the last time.

Supportive comments on a state-owned bank are widely expected and a further update on enabling legislation for licencing the Postbank are likely, but we do not expect any meaningful move on this in the short run.

We see no shift in capital control rules at this time.

We see no shift in the MPC mandate at this time.

Peter Attard Montalto is an analyst for Nomura, based in London

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