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February’s fiscus: Curb your enthusiasm

29 Feb 2020

Rhandzo Mukansi, Wikus Furstenberg, Refilwe Rakale, Yunus January, Daphne Botha, Aidan Kilian / Interest Rate Team

Economic/bond market review

Despite the best efforts and intentions by the Ministry of Finance in guiding the fiscus towards a more stable path, we are unable to find much plausibility in the latest budget proposals and estimates in the absence of buy-in from organised labour.

Significant current expenditure cuts planned and much-reduced reliance on tax revenue to fill the funding gap

For a number of years - and in harmony with the austerity-chorus - we have been banging on the table for more significant expenditure cuts, particularly in the bloated government wage bill, as the main means of slowing the pace of fiscal slippage.  We have also urged caution around relying too much on a small tax revenue base, as more tax increases will be counter-productive in light of sustained weak economic growth (the so-called Laffer-curve effect).  At last, these calls were answered with the tabling of the latest national budget estimates in February 2020.  For more detail, please see a separate article titled Budget 2020/21 and beyond: Our initial thoughts”.

But, sadly and worryingly, these proposals lack credibility       

It is one thing to put great intentions on paper.  It is a completely different matter when the drastic austerity measures require buy-in from an important partner like organised labour that seems reluctant to join the austerity effort on government’s terms.  Planned expenditure savings entail a significant proposed wage bill cut of R160 billion (bn) over the fiscal three-year period.  We are concerned about the size of the planned cuts, especially in the obvious absence of whole-hearted buy-in from organised labour.  As a result, the risk of underperformance relative to the budget is significant.  Moreover, the  proposed budget does not deliver the desired fiscal consolidation.  Instead, the rate of fiscal slippage merely slows down in the outer years of the three-year term.  Thus, an inability to stick to the planned expenditure reductions will have a dramatic negative implication for the fiscal path.  In light of the above, it is difficult to re-consider our long-held view that Moody’s will downgrade the country’s sovereign credit rating to sub-investment, in line with the other two main rating agencies.                   

An initial welcome bull rally lost steam within 48 hours

The initial response of the bond market was one of relief as investors were encouraged by the intention to cut expenditure in such a significant way.  Excess demand pushed yields lower across the nominal bond curve.  In terms of the pivot point, the yield of the R2030 decreased to a best level of 8.69%, well below the weakest point of 9.07% recorded during the first two months of 2020.  However, the rally soon lost momentum.  Apart from increasing doubt regarding the credibility of the budget, a sudden surge in global risk aversion soon played havoc with sentiment.  The latter was closely linked to burgeoning global fear related to the COVID-19 disease, a development that a small open economy like South Africa cannot possibly escape.  The resultant net selling by foreign investors amounted to a very significant R10bn, in turn contributing to upward pressure on yields.  The yield of the 10-year benchmark bond retraced to 9.07%; a market movement reminiscent of the post-MTBPS sell-off at the end of October last year.                  

In contrast to the main event, short term data had a muted impact

Data released for the January readings of both the consumer price index (CPI) and producer price index (PPI) confirmed expectations of an acceleration in the annual rate of inflation, as measured by the respective price indices.  In the case of CPI, the rate of inflation accelerated from the previous month’s 4.0% to 4.5%, which is still well within the 3.0% to 6.0% target band and in line with the mid-point of 4.5%.  One green light had been the release of external merchandise trade account data.  Although January posted a R1.9bn deficit compared to the R13.9bn surplus the previous month, this number is relatively small considering seasonal trade patterns.  In particular, high prices for rhodium and palladium appear to have been a boost for record exports of platinum group metals (PGM).         

Despite recent weakness, nominal bonds are still the top performing sub-interest rate bearing asset class

At the end of February, the JSE All Bond Index (ALBI) recorded a total return of 1.1% for the first two months of 2020.  This is just ahead of the 1.0% return from cash (and somewhat better than the 0.4% returned by the JSE Inflation-linked Government Bond Index (IGOV).  This comes despite the tables being turned in February as the IGOV rendered a return of 0.3%, well ahead of the -0.5% of the ALBI.  Cash took podium position with a steady 0.5%.   


Despite the best efforts and intentions by the Ministry of Finance in guiding the fiscus towards a more stable path, we are unable to find much plausibility in the latest budget proposals and estimates in the absence of buy-in from organised labour.  Therefore, the Moody’s ratings downgrade risk remains alive.  That said, the steep positive yield curve slope has discounted a fair amount of the “bad news”.  We would most likely add risk into a significant market sell-off.

Key economic indicators and forecasts (annual averages)


    2016 2017 2018 2019 2020 2021
Gobal GDP   2.5% 3.4% 3.3% 2.6% 2.3% 2.8%
SA GDP   0.4% 1.4% 0.8% 0.4% 0.6% 2.0%
SA Headline CPI   6.3% 5.3% 4.6% 4.1% 4.2% 4.8%
SA Current Account (% of GDP)   -2.9% -2.5% -3.5% -3.2% -3.3% -3.6%

Source: Old Mutual Investment Group