What would it take for SA to be rerated by investors, particularly bond market investors, and by ratings agencies?
The rand, bonds and equities have seen a huge rally over the past month on news of the government of national unity (GNU), outperforming emerging-market peers by miles. But much of that has been a reversal of the risk investors priced in ahead of the election, not yet a rerating as such.
Ratings agency teams have been visiting SA over the past week or two to catch up on developments. But there is as yet little sign that any of the big three are contemplating upping their “stable” outlooks to the “positive” that could be a precursor of a ratings upgrade.
Government long bond yields have come down from the highs they hit on “worst case” fears before the election, reflecting the fact that investors are now more comfortable to accept lower returns to compensate them for the lower risk involved in lending to SA.
But the rally has merely taken yields back to their levels at the start of 2024. And 30-year bonds are still trading at sharply higher yields than their 10-year counterparts, reflecting investors’ scepticism about their chances of getting their money back in the long term.
Growth is the one big challenge. If SA can’t lift its growth rate it’s unlikely to be able to fix its public finances and get a grip on its unsustainable public debt in the long term. Last year’s record load-shedding, combined with the rail and port debacles, really spooked investors.
The reform narrative is going down well, especially now that SA appears to have a reform-minded government in the GNU. But investors and ratings agencies know that reforms take time and that the GNU won’t be easy. They will want to see evidence that SA can attain and sustain higher economic growth rates.
And for both investors and ratings agencies it’s a relative game — they are comparing SA with its emerging-market or BB-rated peers, many of which are doing better.
The other big challenge is fiscal credibility. The absence of a real bond market rerating is despite the apparent turnaround in SA’s public finances in the past three years or so. In the decade leading up to Covid-19, the government consistently and sometimes dramatically underperformed its own budget estimates. However, since 2021 it has consistently met or outperformed its own estimates.
The commodities boom obviously helped, boosting revenue at the same time as the government reined in spending, particularly on public sector wages. But the improvement has survived the end of the boom and is projected to continue over the medium term, based mainly on substantial cuts to spending. The trouble is that the market doesn’t really believe the story, perhaps not surprisingly.
In February finance minister Enoch Godongwana presented a budget that showed the government achieving a primary fiscal surplus for the first time since before the 2008-09 global financial crisis. The primary balance captures the gap between government revenue and spending, excluding interest payments; sustained primary surpluses enable the government to stabilise and eventually start reducing its debt burden — as Godongwana now expects to do from fiscal 2025/26.
Amid the pre-election excitement it went relatively unnoticed when the Treasury’s year end figures showed the government had beaten its own targets slightly, delivering a primary surplus of 0.5% of GDP compared with February’s 0.4% estimate, with the main budget deficit coming in at 4.6% instead of 4.7%.
The Treasury sees the deficit continuing to fall, while the primary surplus steadily widens to 1.8% of GDP by 2026/27, by which time government debt starts to come down off its peak of just over 75%.
Goldman Sachs economist Andrew Matheny is one who believes the government will deliver on, or even better, its targets. The deficit has steadily narrowed since 2021. The government has successfully executed on the spending cuts it promised last year. Rising primary surpluses will be sufficient to stabilise and eventually gradually reduce the stock of government debt, he says.
But that’s not the consensus view. The market still expects the deficit to go back to 5% over the medium term. At best, the market consensus forecast is for a primary balance, not a primary surplus.
Much of the scepticism has been about the government’s ability to stick with promised spending cuts in the face of pressure to bail out Transnet or increase grants. The prospect of a more reform-minded government, including a DA that has fiercely supported fiscal discipline, has not closed the fiscal credibility gap.
If anything, the GNU has widened it. The finance minister and the president previously promised a “reconfigured”, smaller government. Instead, we’ve ended up with a reconfigured but far larger one.
Might a new fiscal anchor or fiscal rule help close that credibility gap? The Treasury undertook in February to propose a new, legislated fiscal anchor “to chart a sustainable long-term path for the public finances”. It’s an issue that’s on investors’ radar screens.
The Treasury is consulting local and international experts on what form an anchor should take. A debt ceiling is the most likely option, though there are other options. And there are complex issues about how to design an anchor that binds future governments to holding the line on sound public finances but allows flexibility in the face of shocks — and prevents officials from gaming the system by fiddling the numbers.
A well-designed anchor could help restore fiscal credibility with investors and ratings agencies, and that should over time help reduce bond yields and borrowing costs, freeing up more money for service delivery. In theory, now is the time to cement the improvements in the public finances with a new fiscal anchor. In practice, the finance minister will have to see whether he wants to use scarce political capital fighting this battle at this time.
However well designed, an anchor won’t work — or even get through parliament — without broad political buy-in. That could be hard to achieve in the context of a difficult and delicate coalition.
A rerating may have to wait then, unless and until the new government starts proving it can deliver a better economy and sounder public finances.
• Joffe is editor at large.
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