Fitch: South Africa Budget Partly Reverses Fiscal Deterioration

Fitch Ratings-Hong Kong/London-February 23: South Africa's budget reverses some of the fiscal deterioration seen in 2017, Fitch Ratings says. However, the need to fund expenditure measures announced in recent months means the consolidation envisaged is relatively modest. It remains to be seen how fiscal policy will evolve under President Ramaphosa in the face of persistent risks to fiscal targets.

The budget, presented by Finance Minister Malusi Gigaba on Wednesday, left the consolidated budget deficit estimate for the current fiscal year ending March 2018 (FY17/18) at 4.3% of GDP but lowered the deficit targets for subsequent years by 0.3-0.4% of GDP compared with October's Medium-Term Budget Policy Statement (MTBPS). The new targets of 3.6% in FY18/19 and FY19/20 and 3.5% in FY20/21 are exactly in line with Fitch's forecasts when we affirmed South Africa's 'BB+'/Stable sovereign rating in November.

This would represent a partial reversal of recent fiscal deterioration. The budget projects that lower deficits would help stabilise the government's debt measure (which excludes local government debt) at 56% of GDP from FY21/22. This trajectory is much better than in the MTBPS, which saw debt reaching 61% in FY20/21 and remaining on an upward trend. But it is still worse than in last February's budget, which implied FY20/21 debt of 52%.

The budget signals a commitment to consolidation that appeared to be waning last October. The improved forecasts relative to the MTBPS are to be achieved despite significant new expenditures, notably on free higher education for large segments of the population, which will cost ZAR12 billion in FY18/19 and ZAR25 billion in FY19/20. The consolidation is due to higher growth forecasts, a mixture of expenditure measures worth ZAR26 billion (0.5% of GDP) and revenue measures worth ZAR36 billion (0.7% of GDP). This includes a politically difficult decision for a 1pp increase in the value-added tax rate.

We also think the government is committed to its expenditure ceiling, which is an important anchor for fiscal policy. The budget estimates that the ceiling will be breached in FY17/18 by a small amount, but the government has marginally lowered ceilings for subsequent years and did not use a provision that would have allowed an upward adjustment for fully funded major policy changes, which could have been applied to the tertiary education initiative.

The budget's GDP growth forecasts (1.5% in 2018, rising to 2.1% in 2020) are stronger than in October but are credible and broadly in line with Fitch's projections. Growth may get a boost from recovering business and investor confidence following the resignation of President Zuma.​​

Nevertheless, fiscal targets are subject to substantial risks, the largest of which stems from state-owned enterprises, notably the electricity company Eskom, whose medium-term finances are under pressure from weak demand growth and the electricity regulator's refusal to grant more substantial tariff increases. The government does not foresee further capital injections for Eskom, and pointed to a number of potential measures, including private-sector participation, to improve its finances. But this approach will face significant political hurdles.

Public-sector wage negotiations ahead of the expiry of the current three-year agreement could put pressure on expenditure. While the budget projects free tertiary education to be fully funded by the VAT increase and other revenue measures, costs may rise as the impact on student numbers is highly uncertain. The planned introduction of National Health Insurance also presents medium-term fiscal risks.

There is also some uncertainty about the ability to reach targets for expenditure reduction, although the relatively tight budgeting system moderates this risk.