beyondbrics

If the intention of Pravin Gordhan, South Africa’s finance minister, was reaffirm to the prudent fiscal credentials of his Treasury and send a message to wary ratings agencies, the initial reaction to his budget on Wednesday suggests he succeeded.

Bonds strengthened while he spoke. But they later retreated as investors judged the tough targets he had set might be hard to meet. The yield on the 2026 bond rose to 8.24 per cent from an earlier low of 8.18 per cent. The rand held steady at around 7.70 to the dollar.

Gordhan surprised market watchers by projecting a budget deficit of 4.6 per cent of gross domestic product for 2012/13, down on 4.8 per cent for the previous financial year and below economists’ estimates averaging 5.4 per cent.

He forecast a decline in the deficit to 3 per cent of GDP in 2014/15, with public debt to stabilise at about 38 per cent of GDP.

Kevin Lings, chief economist at Stanlib, said the lower-than-expected deficit was partly the result of a slow down in the growth of government spending. He calculated that while government expenditure grew by an average of 13.5 per cent per annum over the past four years, the finance minister was now factoring in growth of 8.8 per cent.

“On the surface it’s going to be very pleasing for the credit rating agencies, the bond markets,” Lings told beyondbrics.

In recent, months both Moody’s and Fitch revised South Africa’s outlook from stable to negative because of concerns about the economy’s inability to create sufficient jobs and the risk that popular pressures could threaten the government’s commitment to low deficits.

The ratings agencies’ concerns were revealed against a backdrop of complaints about policy uncertainty and a controversial debate over the nationalisation of mines, led by Julius Malema, the suspended African National Congress’s youth leader. His outbursts damaged investor sentiment, but also put the spotlight on widespread poverty and high unemployment in one of the world’s most unequal societies.

The government has sought to put the nationalisation debate to bed, with senior officials, including Jacob Zuma, the president, recently insisting it was not the policy of the government or the ANC.

Gordhan’s budget may go some way to reassuring concerns that the fiscal discipline that the Treasury and central bank have been credited with since 1994 is not at risk.

Annabel Bishop, economist at Investec said:

The alarming trend of a widening in the projected budget deficits as a % of GDP for the 2011/12 to 2013/14 period that occurred last year was not only removed in this year’s budget, but fiscal consolidation (budget deficit of 3.0% of GDP) is firmly projected for 2014/15 amid fears that this would slip into a later period.

“The substantial improvement in government’s projected finances occurs on the back of an upward revision in revenue collection and downward revision in expenditure for the relevant periods, compared to these projections as a % of GDP in the 2011 MTBPS. Hopefully this reduction in expenditure occurs in civil servant remuneration while the increase in revenue is not due to a rise in tax rates but rather improved revenue collection itself, particularly in industries which previously have escaped the taxation net.

But the projections do rely on South Africa hitting growth forecasts. As expected, GDP growth for 2012 was revised downwards to 2.7 per cent, with the blame placed largely on the eurozone crisis with South Africa sending about a third of its manufactured exports to Europe.

If the outlook deteriorates any further, that will strain the fiscal belt.

Gordhan’s biggest challenge is likely to be keeping public sector salary hikes – a significant proportion of government expenditure – at a sustainable rate. Inflation rose to 6.3 per cent in January, unemployment remains stubbornly around 24 per cent and powerful unions have consistently pushed for above-inflation salary increases, arguing the rises are need to reduce the gaping gaps in SA society.

“The test is going to be can he keep government expenditure (growth) at 8.8 per cent and in that, in particular can he keep the wage bill under control,” Lings said. “And if he can’t keep the wage bill under control … does it mean that areas that take more pain are all the delivery factors, in terms of basic services. That to me is the test that he faces.”

Tax rises included a dividend withholding tax of 15 per cent to come into effect on 1 April, and increases in capital gains tax, as well as rises on fuel, alcohol and cigarettes.

Gordhan reiterated plans to significantly invest in infrastructure upgrades – a key part of its strategy to boost job creation and the competitiveness of South Africa. He did, however, acknowledge that only an estimated 68 per cent of a planned R260bn was spent on infrastructure in 2010/2011.

Without infrastructure improvements, GDP growth targets will be harder to reach – and so will fiscal goals.

Related reading:
Gateway to Africa: Investment springboard found to have flaws, FT
South Africa: more strikes in 2012, beyondbrics
S Africa: weak rand boosts inflation, beyondbrics
S Africa: global slowdown hits home, beyondbrics
South Africa: Contradictions to confront, FT