Fitch: Weaker Growth Pressures South Africa’s Fiscal Consolidation

South Africa’s latest medium-term budget policy statement shows evidence of further weakening in the country’s public finances, with consolidation targets pushed back again by slower than expected growth, according to Fitch Ratings.

The credit ratings agency (CRA) says that failure to deliver projected fiscal consolidation continues to erode one of the sovereign’s key rating strengths compared with its peers. This erosion contributed to Fitch’s decision to revise the outlook on South Africa to negative in January.

South Africa’s government projected a deficit of 4.6% of gross domestic product (GDP) for the fiscal year (FY) 2012-13 in February 2012. This has been revised up to 4.8% for the current FY. The government also appears to be falling behind on its longer-term fiscal consolidation programme. In October 2010 the finance minister projected that the deficit would be reduced to 3.2% of GDP by FY2013-14; this was raised to 4% in February 2012 and is now projected at 4.5%. Although this reflects weaker-than-expected revenue growth, rather than higher expenditure, the further delay to fiscal consolidation highlights the challenges to fiscal planning and will put upward pressure on debt levels.

Gross debt is now forecast to peak at 42.7% of GDP in FY2015-16 – slightly above BBB rated peers. This is up from 27% of GDP in 2008, when South Africa’s debt ratio was among the lowest in the BBB category. Rising debt will also see interest payments as a percentage of revenue rising further above the ‘BBB’ median – a situation which would be aggravated if bond yields rose. The inverse correlation between bond yields and foreign bond purchases has been notable in recent years, suggesting that a substantial fall in investor confidence could lead to a sharp rise in borrowing costs. Foreigners have purchased a hefty 84bn of South African rand (ZAR) domestic bonds since January 2012, compared with Treasury’s planned issuance of around ZAR150bn for the current fiscal year. Reduced foreign appetite for domestic debt could put upward pressure on yields, although in the short term the inclusion of South Africa in a key global bond index provides a boost.

Further spending increases (as a proportion of GDP), especially non-discretionary, will limit South Africa’s already diminished fiscal headroom. High current expenditure, which includes spending on wages, subsidies and interest, makes up just over 90% of total expenditure and restricts the fiscal room available to counteract any economic shocks. It also limits the government’s ability to deliver its ambitious infrastructure spending plans without taking on additional debt.

Growth projections have also been revised lower over the past year, with negative implications for employment creation and debt dynamics. In late 2011 economists polled by Reuters projected growth of 3% and 3.7% for 2012 and 2013 respectively; this has now been revised down to 2.5% and 3.0%, in line with Treasury’s forecasts. As Fitch highlighted in January, failure to accelerate growth and make it more sustainably labour intensive would hamper job creation and increase the risk of social strife, with negative implications for the investment climate and credit fundamentals.

The CRA has also highlighted long-standing structural problems that have contributed to South Africa’s weakening growth performance compared to peers, especially in education and labour reform. Last year’s national development plan acknowledged that this has resulted in insufficient growth to create the jobs required to put a dent in an unemployment rate of 25%.

Fitch rates South Africa’s long-term foreign currency international depository receipt (IDR) as BBB+ and says that it expects to complete its annual rating review early in 2013.

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