Structural Adjustment

The ratings agencies have put South Africa on terms. Everything now depends on the outcome of Moody’s rating review for downgrade, which may not conclude until after the Budget is presented in February 2018.
Structural  Adjustment

Moody’s wants to see:

  • growth-supportive fiscal adjustments that raise revenues and contain expenditures
  • structural economic reforms that ease domestic bottlenecks to growth
  • improvements to state owned enterprise governance that contain contingent liabilities

Can we deliver?

The necessary conditions are:

  1. Change the mix between fiscal and monetary policy.  Raising government revenue and cutting expenditure is deflationary.  In principle, it can be offset by expansionary monetary policy.  In practice, there are complications. 
  • The documentation accompanying the Reserve Bank Monetary Policy Committee’s (MPC) statement of 23 November 2017 projects the real natural interest rate to rise from 1.7% in 2017 to 2.0% in 2018 and 2.2% in 2019.  There is also a projected rise in the core Consumer Price Index from 4.8% in 2017 to 5.1% in 2018 and 5.3% in 2019.  Accordingly, the repo rate is projected to rise from its current rate of 6.75% to 7.1% at the end of 2018 and 7.5% at the end of 2019.
  • The two foreseeable short-term risks are the outcome of the ANC electoral conference and a Moody’s downgrade. The latter would precipitate a significant sell-off of domestic government bonds by non-residents, with implications for the exchange rate and long-term bond yields.  The MPC sees the path and duration of adjustments as highly uncertain.  An expansionary monetary policy requires both risks to be resolved positively, and also that fiscal deterioration be arrested.
  1. Contain public sector wages.  The October 2017 Medium Term Budgetary Policy Statement assumes that the coming wage settlement will be at the level of the Consumer Price Index, implying no increase in real wages.  The MTBPS estimates that a CPI + 1% agreement would raise the national shortfall in 2018/19 to R8.2 billion, with the gap in provincial compensation budgets amounting to R4 billion.   A zero real wage increase is not what the public sector is used to: the average annual increase in real wages between 2008/09 and 2016/17 was 3.3%.   The unions tabled their demands on 6 October 2017.  A response was expected from the government on 20 October.  That was postponed until 23 November and it has been postponed again until 7 December.  A sharp confrontation is looming.  Moreover, even if a CPI agreement is reached, it throws the whole weight of expenditure adjustment on the 54% of government expenditure other than compensation of employees and debt-service costs.
  1. Get serious about government-business relationships.  Quite useless will be one more round of a summit which issues anodyne statements about the need to work together followed by working groups which go nowhere. What is needed is access, particularly to the President and Minister of Finance, and a more favourable tone in relation to all business.  The Mining Charter in its current form needs to be withdrawn altogether, as a prelude to fresh negotiations.   Budget 2018 cannot contain an increase in the corporate tax rate.  If VAT cannot be increased either, the whole burden of revenue adjustment is thrown on to personal income tax and some excise taxes. 
  1. Take big ticket items off the table altogether, or tie implementation to GDP rather than dates.  Nuclear power falls into the first category.  Changes in the health system and government contributions to student financing fall into the second.
  1. Announce and start to implement a clear anti-corruption strategy.  The current level of impunity has to be reduced sharply and quickly.  High level indictments would help, as would indications of rapid progress of investigations.  So many leads are available, that continued inaction confirms that the criminal justice system has been subordinated to personal interests.
  1. Deal decisively with the Eskom crisis.  The crisis is coming to a head.  Eskom’s liquidity has deteriorated to critically low levels.  The National Energy Regulator’s decision on electricity tariffs is expected on 7 December 2017.  Eskom has structural adjustment of its own to do, in respect of both operating expenditure and its capital programme.  The National Treasury needs to exert all its leverage to ensure that the adjustment gets done.    
  1. Create appropriate expectations.  It is not possible that all the necessary structural adjustment gets done by Budget Day on 22 February 2018.  Between the end of November and then, just 55 working days remain and summer holidays intervene.  The ANC electoral conference will have us in thrall.  But by Budget Day, a credible programme of adjustment must be in place.
  1. Accept that significant drops in real household disposable income are coming.  This will be an inevitable consequence of declining real GDP per capita and increased taxation.  Structural adjustment is always hated for this reason.  But the problem is not the programme: it is in the conditions that make it necessary.
  1. Political preconditions have to be satisfied.  Moody’s puts it delicately:

The review period will also allow Moody's to take stock of the implications of political developments for key structural reforms that could boost investor confidence in the near term and support higher growth trends over the medium- and longer-term.

That is code.  South Africans can be blunt.  A postponed conference, a failed conference or a win on a radical economic transformation ticket, are all 100% downgrade outcomes, as would be the absence of a swift presidential recall.  Disruption of patrimonial relationships is essential.

Impossible, you say?  You may well be right. 

Charles Simkins
Head of Research