Fiscal consolidation plans are more realistic, but the path remains very slippery
Broadly speaking, the commitment to fiscal consolidation with the June Supplementary Budget was repeated with the tabling of the Medium Term Budget Policy Statement (MTBPS) on 28 October. Compared to the Supplementary Budget, the MTBPS appears to be more credible in terms of the size of the proposed expenditure reduction and the more likely public sector debt path. In essence, the focus remains (as it should, in light of the country’s low growth trap) on expenditure management as opposed to higher tax revenue collection. The lower but more realistic cumulative expenditure cut for the fiscal years 2021/22 and 2022/23 of R139 billion, compared to the estimate of R230 billion in June, is also closer to our more conservative estimate of R115 billion.
In terms of implementation risk, our biggest concern remains the pencilling of a reduction of the public sector wage bill, which has now increased to approximately R240 billion over the medium term (i.e. an increase of R78 billion from February’s initial R160 billion baseline reduction), which is in addition to the R139 billion expenditure cut. Although welcomed, execution risk is very high in light of the upcoming labour court ruling and the fact that negotiations on the upcoming wage cycle between government and organised labour are yet to start.
We also fear that the MTBPS underestimates the size of financial support to state-owned enterprises (SOEs) and other spheres of government, including a growing number of financially distressed municipalities. Even if these risks do not crystalise, the latest consolidated budget deficits still range between a high of 15.7% for the current fiscal year and a low of 7.3% for 2023/24, in turn calling for a large borrowing requirement. As a result, the public sector debt ratio is only expected to peak in 2025/26 at 95.3%, around 8% higher and two years later than the June estimates.
Figure 1: Consolidated public sector debt and weekly bond issuance
Source: National Treasury, Futuregrowth
Foreign investors on a selling spree again
While the pace of net foreign selling has slowed over the past few months, data for the month of October suggests that selling has regained some momentum. Foreign investors in local currency RSA government bonds reduced their holdings by R14 billion in the past month, taking total net sales for the first ten months of 2020 to R86 billion. Renewed risks to the fragile global economic recovery in light of renewed lockdown measures in large parts of the northern hemisphere and unconvincing efforts to reduce the pace of fiscal slippage at home contributed to the latest wave of risk aversion.
Growing evidence of a third quarter current account surplus
The September merchandise trade surplus was reported to be a high R33.5 billion, the latest of a string of positive numbers since the lifting of hard lockdown measures in the second quarter. Similar to previous months, this was the result of a significant increase in merchandise exports, while non-oil imports in particular are down sharply. The latest data is a clear reflection of excellent terms of trade, pointing to a current account surplus for the third quarter of this year. While the much-improved external trade account is welcomed, the flip side is that depressed import demand reflects the extent of weak domestic economic conditions and the slow recovery from the effects of the pandemic.
Inflationary pressure remains very subdued
The year-on-year headline Consumer Price Index (CPI) change for September slipped back to 3.0% from 3.1% the previous month. This was due to disinflation in the vast majority of major components, including food inflation. More importantly, the indicators of underlying inflation, i.e. headline CPI excluding administered prices, the Retail Sales deflator and core CPI all point to persistent muted inflation. The latest Producer Price Index release suggests similar strong disinflationary forces at the wholesale level.
A relatively strong month for both nominal and inflation-linked bonds despite a month-end setback
As in the previous month, local investor demand continued to save the day, which brought about some stability in both the nominal and inflation-linked bond markets. On the nominal side, the FTSE JSE All Bond Index (ALBI) rendered a return of 0.86% for October with all the sectors doing well with the exception of the ALBI 12+ Year maturity band. Inflation-linked bonds ended the month with a third straight month of positive returns. The FTSE JSE Government Inflation-linked Index (IGOV) managed to eke out a return of 1.11%, beating both cash (0.28%) and nominal bonds. Returns for the first ten months of the year show cash still firmly in first position at 3.91%, followed by the ALBI (2.70%) and, in last place, the IGOV, which rendered a return of -0.36%.
Figure 2: Bond market returns (periods ending 31 October 2020)
Source: JSE, Futuregrowth
// THE TAKEOUT
Although inflation is slowly regaining positive momentum, strong disinflationary forces are undoubtedly still at play. Even so, a cautious central bank opted to keep the repo rate unchanged at the last MPC meeting, following a series of unprecedented cuts that left the repo rate at an all-time low of 3.50%. While economic activity appears to be picking up following the devastating impact of the national lockdown in the second quarter, it is still well below pre-lockdown levels. This does not bode well for a fiscal situation that is already at its most fragile in many years, and unfortunately supports our scepticism about government’s ambitious expenditure reduction plan. The combination of stable monetary policy and an increasingly slippery fiscal path imply an anchored short end, but upside risks to the yields of longer-dated fixed and inflation-linked instruments.