Finance Minister Enoch Godongwana will have to turn on the razzle-dazzle during his Budget Speech on 19 February if he is to convince local and foreign investors that he has a plan to arrest the country’s weak economic growth.
The country’s crippling debt-to-GDP ratio will make it even more challenging for Godongwana to balance boosting economic growth with supporting the vulnerable.
The debt-to-GDP ratio measures a country’s total government debt relative to its economic output. A higher ratio indicates that a country owes more compared to the size of its economy.
Research suggests that when a country’s debt-to-GDP ratio exceeds 37%, it may negatively affect economic growth. As of September 2024, South Africa’s government debt stood at 75.1% of its nominal GDP.
Chief economist Annabel Bishop, treasury economist Tertia Jacobs, and chief investment strategist Chris Holdsworth from Investec all agree that the debt-to-GDP trajectory will be a key factor shaping the entire Budget analysis. The three experts shared their predictions for Budget 2025 during Investec’s No Ordinary Wednesday podcast.
Debt trajectory – that’s what makes the world go around
As the lawyers would put it, it’s common cause that lowering the government’s debt trajectory is no easy feat.
According to Bishop, the real issue is a lack of revenue and profitability.
“There is not enough business going on in South Africa,” she said.
She points out that fiscal slippage – the deterioration of government finances – has been a persistent trend over the past decade.
“The result of that trend of fiscal slippage over the past decade, and of course, this decade, has really been to see higher borrowing costs, which has resulted in higher bond yields, weakening in the rand, and worries around downgrading of South Africa’s credit ratings.”
Bishop believes that stronger economic growth is key to improving the country’s fiscal position.
“If we had around 0.5% last year, we’ve got 1.8% for this year, and then going above 2%, going forwards towards 3%, that will make a big difference. That’s what the government is counting on to bring these ratios down, whether it’s the government debt or fiscal deficit ratios.”
On the possibility of lowering the debt-to-GDP ratio, Jacobs said the base-case scenario is for it to stabilise at around 75% to 77% over the medium term.
“And from that perspective, it will be very difficult for us to get to investment grade. But I think what we’re hoping for is a holding year for the budget while we’re waiting for economic growth to kick in in the outer years,” Bishop said.
Tax policy changes – what to expect
Expectations are low for any big tax changes in this year’s Budget.
Jacobs said fiscal drag has become an easy source of revenue in previous budget projections.
“When you get a salary increase, you go into the next tax bracket, and the brackets don’t get adjusted, and that generates like nearly R15, R16 billion per annum. So that’s in the baseline forecast for the coming year as well.”
This is taking a toll on households’ balance sheets.
“The question is, will they keep that number as is, or will there be a bit of alleviation?”
“Sin taxes” remain a standard revenue measure.
Then, a potential wealth tax is also on the radar. In November last year, National Treasury indicated it would consider such a tax once it had analysed data collected by the South African Revenue Service on high-net-worth individuals.
Read: Treasury analysing SARS data in considering a possible wealth tax
Jacobs believes this is unlikely for this year.
Another key question is whether the Social Relief of Distress grant will become permanent.
“There has to be a financing source for it. There is money set aside for the next two years. But looking ahead, I’m not sure that we’re there yet,” Jacobs said.
From an investment perspective, Holdsworth said tax changes are unlikely to have a significant impact on the bottom line.
“But we would expect to see some clarity around how trades for collective investment schemes (CIS) are going to be taxed.”
National Treasury published several proposals at the end of last year aimed at providing certainty to the CIS industry on the taxation of returns within funds.
Industry roleplayers have alerted Treasury to the negative impact its proposals will have on liquidity in the South African market and on saving.
Read: Industry raises red flags over tax treatment of collective investment schemes
Holdsworth said although there could be implications for the asset management industry, it is unlikely to affect overall revenue or have a major impact on the equity market, because no significant tax policy changes are expected.
Instead, he believes the focus will be on fixed-income markets and discussions around potential credit rating upgrades and the possibility of South Africa regaining investment-grade status.
“But from an equity market perspective, we’re not expecting a material reaction. And it’s often been the case over time that markets, equity markets in particular, have not reacted materially to the Budget. It’s often that you’ll see the interest in the equity side of things, or fixed income. So, our focus is not directly on equity reactions, more from fixed income and the currency.”
Maintaining the status quo
With tax revenue stretched to its limit, the government’s best bet lies in growth – or, at the very least, stabilisation in the short term.
Over the past decade, South Africa’s economic growth has been anything but stable, marked by periods of modest expansion, sharp contractions, and sluggish recoveries. More recently, growth moderated to 1.9% in 2022, and by 2023, projections had been revised downward to 1.1% from an earlier estimate of 1.3%, according to Reuters.
Holdsworth said weak growth has been the defining characteristic of the past few years, dampening expectations for any significant turnaround. However, he sees an opportunity amid the low forecasts.
“If you look at the consensus forecast for growth this year, it’s between 1.5% and 1.7%, and the year after, it’s just a bit above that, and that puts South Africa in the bottom 20% of countries across the globe,” he said.
It should not be hard to beat that.
“Even if we see a modest improvement, we are likely to see numbers that come out in excess of expectations.”
He points to the country’s debt-to-GDP trajectory as another key factor.
“If you look, for example, we’re talking about the debt-to-GDP trajectory, and how there might be a revenue measure – 75 to 77. S&P expects 80. And so, what we really have to do, what Treasury has to do, is deliver roughly in line with what they guided in the Medium-Term Budget Policy Statement.”
In his view, simply maintaining the current fiscal stance could be enough to shift market sentiment.
“We would expect to see potential for an upgrade, even without improving numbers, if they just stay in the status quo, because the expectation is for deterioration. So, just staying where we are is better than expected, and with the rating upgrade would come lower cost of capital, and that would engender faster growth as well.”
Could things be looking up?
In other words, a holding year – as discussed earlier – as South Africa waits for growth to kick in, which, Bishop adds, may not be as unlikely as most believe.
Economic growth, she said, organically builds revenue.
“High levels of government revenue coming from fast economic growth. And when that happens, you get higher revenue coming in from taxation on VAT, on companies, personal income tax, customs and excise – all of those occur when your economy is growing at a rate of close to 3%.”
She acknowledges that the economy has been very weak for the past several years, and the expectation is that it will continue to be weak. This, of course, has had a negative impact on business confidence, which remains depressed.
“The upside will come when businesses start to realise the government has actually delivered more than expected.”
For example, she recalls that at last year’s State of the Nation Address (SONA), many questioned the government’s claim that the electricity crisis would be resolved soon.
“And yet, that’s what happened. Now, in the SONA this year, they’re talking about ending the freight crisis quite soon.”
She believes these factors will gradually contribute to supporting growth.
She said President Cyril Ramaphosa made the statement that the weakness of the freight sector subtracts 3% from economic growth during his 2023 SONA.
“Now what does that mean? That we should be closer to 3.5% to 4%. Now that would be very surprising for investors, for the business community, for the credit rating agencies.”
She said that when you read what the credit rating agencies write, a lot of it centres on economic growth in South Africa as a resolution to many issues.
“While we probably are going to have a weakish year this year from a GDP perspective, I think it’ll be the year that things start to turn and we start to certainly see strong growth from next year,” Bishop said.
What about bond yields?
Bond yields re-rated in the second half of last year, but can another re-rating be expected in the year ahead? Jacobs does not think so.
“Because this is where the growth discussion is coming in. But if it’s like a holding pattern, that will certainly start building up confidence.”
She added that from an external perspective, United States policy will be critical – particularly what happens to the budget deficit, which will influence the 10-year Treasury yield.
“In South Africa, the direction of inflation is going to be quite important. We think that can hold sub-3.5% in the first half, and perhaps just between 4% or so in the second half. That’s still broadly supportive of bond yields.”
Jacobs sees bond yields consolidating rather than rallying.
“[We are] also watching what the government is going to announce around bond supply, which we expect to remain unchanged. But for bond yields to rally meaningfully further, we really need foreign buyers to come in, and that is where the investment-grade rating becomes quite important.”
South Africa was first downgraded to junk status by S&P Global Ratings in April 2017. Moody’s and Fitch followed with their own downgrades, pushing the country further below investment grade.
A junk rating signals a higher risk of default on sovereign debt, increasing borrowing costs for the government, businesses, and consumers.
Holdsworth said South Africa’s credit rating is currently two to three notches below investment grade, depending on the agency. If the base-case scenario holds and the country maintains its current trajectory into 2025, he believes that will justify one upgrade.
“For that extra one to two upgrades, you need growth trending towards 3% to pan out. And that pans out over, say, three years.”
However, he cautions that the outlook remains uncertain.
“At the moment, we’re basing this on growth getting back to 3%. It could happen. We hope it’s going to happen, but we could have a recession in that period. So, we don’t want to be too precise, but I think three years as a base case is reasonable.”
