Markets received Budget 2023 positively, evident in a near-20 basis point (bp) rally in the benchmark 10-year yield and the 20c rally in the rand versus the dollar. While these are not exceptionally large moves, they do signal a positive stance or at least relief that the government has not changed tack on its fiscal strategy.
Finance Minister Godongwana tabled the FY23/24 Budget in parliament amid heightened uncertainty about the fiscal trajectory, Eskom’s sustainability, and the pending Financial Action Task Force (FATF) Grey-listing.
Importantly, the direction laid out in the 2022 Medium Term Budget Policy Statement (MTBPS) in October last year was one of ongoing consolidation with a return to a primary budget surplus (i.e. revenue less non-interest expenditure). This budget follows through, with the consolidated budget deficit narrowing from an estimated 4.2% of GDP in FY23 to 3.2% in FY26. Encouragingly, the government is set to deliver a primary surplus (of 0.1%/GDP) a year earlier (in FY23). A return to primary surpluses will contribute towards stabilising the debt ratio the medium term.
The Eskom enigma
The big unknown was how government would credibly deal with Eskom’s debt. Market participants were disappointed in October when the Treasury gave a vague range for the quantum that it was willing to take on. This time around there was more detail in terms of the quantum and timeline.
From FY24 to FY26 government will support Eskom to the total of R254bn. This entails an interest-free subordinated loan of R78bn in FY24, R66bn on FY25 and R40bn in FY26, as well as a debt swap of R70bn. This will be funded by borrowing, with R66bn already incorporated in the Medium Term Expenditure Framework in the MTBPS. The fact that the debt swap only occurs in FY26 suggests that the process has been intricate and complicated and that the technicalities of explicitly replacing Eskom debt with government debt are yet to be finalised. As such, the option of continuing with effective cash injections is a sound decision, as it is relatively simple and transparent.
While much of the detail will be made available by the end of March 2023, the government has effectively taken the Eskom cash injections out of the income and expenditure statement and moved it to the balance sheet. Government has an asset – the loan to Eskom – that will be replaced over time by a different asset – equity stake in Eskom. While Eskom has a liability to government, it will be repaid in shares rather than cash.
Lower deficits but higher debt
This flatters with deficit metrics, which are marginally better than what was projected in October, but it lifts the debt profiled by 3.6 percentage points (ppt) by FY26. Hence, the Eskom support will require that government borrows more than what was estimated before. The fact that the bond market has not weakened due to a higher debt trajectory is a function of the funding strategy that seems to rely more heavily on cash, Treasury bills, and floating rate notes. Based on our estimates there is no need to increase issuance in fixed-rate or inflation-linked bonds in 2023.
This does not mean there are no risks. The Special Relief of Distress grant is set to end in March 2024, with no indication of what will replace it. However, the budget includes an unallocated reserve that could cover a narrow income support grant, such as a job-seekers grant. The wage bill has again made media headlines. While there is notable upside risk to this expenditure line item, this will only come to the fore when wage negotiations are concluded later this year.
Credit rating likely to remain steady
We think this budget will hold the line on stabilising the sovereign credit rating outlook, and is a net positive against a global backdrop where fiscal strain is in focus in other emerging markets. As long as SA policy remains relatively conservative and transparent, we should be able to attract our fair share of portfolio inflows.
From a monetary policy perspective, we think the budget is broadly neutral. Fiscal risks have been less of a constraint on the South African Reserve Bank (SARB) over the past three years in light of the positive terms of trade benefit and improvement in revenue collection by the South African Revenue Service. Rather than local factors, the SARB remains a price taker on the policy stance given the Federal Reserve’s signal that further rate hikes may be required. To be sure, the markets have vacillated between calling the end of the hikes in January to now expecting ongoing policy tightening.
Notwithstanding positive aspects in this budget and seemingly a more sustainable fiscal path, we should be cognisant when looking at the aggregate picture that the Treasury team delivered a positive budget with some creative accounting.