Tough Times Ahead For South Africa But No Downgrade Yet Says Standard Chartered

Falling tax receipts could see South Africa's budget deficit rise to 4.5% of GDP in 2018, endangering its investment grade status, but the right mix of policies in the forthcoming budget may mean it avoids action from ratings agencies. 

South African politicians face tough choices over the coming week if they are to craft a credible plan for dealing with a widening budget deficit, according to strategists at Standard Chartered, although the right mix of policies could see South Africa avoid a ratings downgrade in November and the subsequent year.

Falling import VAT and customs duties during the fiscal year to date, as well as lower than expected revenue elsewhere, now threaten South Africa’s deficit targets and have put the nation’s credit rating back in the spotlight.

“We are concerned that both growth and GDP inflation will be lower than initially assumed by National Treasury forecasts – and predict a 4.1% of GDP budget deficit in FY18,” says Razia Khan, chief Africa economist at Standard Chartered.

The South African government forecast in February that the budget deficit would fall to 3.1% by year-end. But the economist consensus now suggests it will be around 3.9% of GDP, while Standard Chartered forecasts 4.1% of GDP.

“The South African Reserve Bank (SARB), in its most recent Monetary Policy Review, suggested a 4.5% of GDP deficit if no remedial action were taken. The Treasury’s own projections will be a key focus on Wednesday,” says Khan.

The shortfall connected to the revenue miss could be anywhere between ZAR 40 billion and ZAR 52 billion.

“A VAT hike remains important. Not only is it a less-distortive tax compared with alternatives, but it is also the one measure that is most likely to raise significant revenue,” writes Khan, in a note Tuesday.

The South African government is now faced with a politically challenging situation where it must raise revenue and cut spending if it is to avoid action from ratings agencies.

“We estimate that a 1ppt increase in the VAT rate could raise as much as ZAR 22 - 23bn of additional revenue,” Khan adds.

Cutting spending may be difficult for the government in the current economic environment, given South Africa’s recent emergence from recession, and the fact that it has already scheduled ZAR 25 billion of cuts for the coming years.

“A 2-3ppt rise – although only expected to take effect from FY19 at the earliest – might compensate for all of the revenue shortfall South Africa has seen in the current fiscal year,” says Khan.

The deterioration of the budget deficit and subsequent scrutiny of the credit rating comes at a pivotal time in South African politics.

In December the ruling ANC Party will vote on who leads them into the 2019 election. 

Delegates will choose whether to go forward with a new leader who eschews the corruption of the past (Cyril Ramaphosa), they can choose a continuation of the status quo (Nkosazana Dlamini-Zuma) or they can attempt to find a middle ground somewhere between the two extremes (Zweli Mkhize).

“Although we do not expect more rating downgrades ahead of December, the MTBPS will probably have to provide more meaningful reassurance on growth, government deficits and rising debt in order to lessen future rating risks,” says Khan.

The fate of South Africa’s investment grade credit rating, and economic future, is hinged largely on the contents of October’s budget plan and what happens at the December ANC vote. 

For an explainer of the December ANC vote and its implications for the South African Rand, see our report titled; South African Rand Could See Double-digit Gains Toward Year-end.

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