MTBPS: More creditworthy & monetary policy friendly

FX

Finance Minister (FM) Nhlanhla Nene tabled the MTBPS in parliament yesterday. This was the FM’s first official bi-annual budget event since his appointment. Government was keen to remind us of a warning in the February 2014 Budget that “additional measures to ensure fiscal sustainability would be required if the economic outlook were to worsen”. It then went on to say: ”That turning point has been reached”. The MTBPS reveals a clear effort on the part of government to limit the scope for further slippage in fiscal metrics associated with cyclical risks to revenue performance. Proposed “discretionary” adjustments contained in a new “fiscal package” included expenditure adjustments (downwards) as well as tax policy and administrative adjustments (upwards). The MTBPS could be viewed as rand-positive from a creditworthiness perspective, directly tackling concerns about one of the country’s large twin deficits, which have been key points of concern for foreign investors as we head along the path of Fed policy normalisation. However, a less accommodative fiscal stance is (in the nearer term) growth-negative; this might reinforce the SARB’s reluctance to tighten monetary policy, which could be viewed as rand-negative. More immediately, we think the positive creditworthiness implications will dominate the local currency market response, perhaps via improved appetite for local bonds. The MTBPS is local bond market friendly from a creditworthiness and thus debt-rating perspective, and via the extent to which it perhaps takes some of the burden of required policy adjustment into more challenging external financing circumstances off the SARB’s shoulders. It is less equity market friendly over the short- to medium term via its consequences for growth, although it should be viewed as positive from a macroeconomic and financial stability perspective, and thus from a long-term economic growth point of view.

National Treasury (NT) lowered its forecasts for real GDP growth downwards over each year of the MTEF. The estimate for 2014 growth was most notably revised, down to 1.4% from the 2.7% indicated in the February Budget. Forecasts now stand at 2.5% for 2015 and 2.8% for 2016, compared to the previous 3.2% and 3.5%. Growth in 2017 is pinned at 3.0%. This brings projections more in line with views in local financial markets. The new estimate for 2014 contradicts the FM’s remarks a few weeks back that government’s expectations were not as grim as the IMF’s recently revised outlook. Government’s headline CPI inflation forecasts appear reasonable, although perhaps a little to the high side into next year. There is possibly some adverse risk in NT’s forecast for the GDP deflator; GDP inflation is seen running above headline CPI inflation, contrary to the bias evident for the most part in recent years. It is perhaps more concerning that official estimates of GDP implicitly factor in the less accommodative fiscal stance. It is not clear that this is fully factored into consensus forecasts for GDP growth; all else remaining equal, this might tilt risks to the median growth view to the lower side. There could be some offset in the implications of a less accommodative fiscal stance for monetary policy accommodation, but it should be borne in mind that real economy impacts of fiscal policy adjustments tend to be more immediate. There could also be some protection in typically conservative assumptions for revenue elasticities relative to GDP performance, but the risk that some additional fiscal catch-up to a sliding growth curve could be required is non-negligible. While the MTBPS perhaps takes some of the wind out of the February 2015 Budget’s sails by including impacts of tax proposals, we would be inclined to view the demonstration of a commitment to a fiscal deficit speed limit in a positive light. The inclusion of these proposals in the MTBPS suggests also that there might be adequate political backing for a less accommodative fiscal stance.

The budget deficit in FY14/15 was pinned at -4.1% of GDP, slipping slightly against the -4.0% estimated in the February Budget. But slippage in the deficit versus February Budget estimates was confined to the current fiscal year. The deficit target for FY15/16 stays at -3.6% and, for FY16/17, now sits at -2.6% against a February estimate of -2.8%. For FY17/18 (now added to the end of the three-year MTEF), the deficit target is set at -2.5%. Estimates for government’s debt to GDP ratios nevertheless deteriorated against February estimates, both on a gross and net basis. Government’s net loan debt to GDP ratio was raised to 42.8% from 41.9% for FY14/15, to 44.6% from 43.5% for FY15/16, and to 45.4% from 44.3% for FY16/17. It was seen rising to 45.9% in FY17/18, but is then seen “declining thereafter”, thanks to the new fiscal package. However, it is important to point out here that the rand value of government’s net debt position was lowered in each year of the MTEF, which tells us thus that the kick-up in the net loan to GDP ratio was simply owing to a smaller (nominal GDP) denominator. The rand value of government’s gross loan debt to GDP was taken higher. The apparent discrepancy here arises because government plans to burn less of its cash balances in the coming years. This should be seen as reducing rather than increasing risks seen in government’s funding equation.

Gross tax revenue estimates were revised lower compared with estimates provided in the February Budget on the back of a weaker economic growth outlook; ZAR10.0 billion in FY14/15, ZAR19.1 billion in FY15/16 and ZAR31.8 billion in FY16/17. Government expects that proposed tax policy and administration changes to be tabled in the 2015 Budget, consistent with recommendations made by the Davis Tax Committee, are expected to narrow these revenue shortfalls (associated with weaker growth assumptions) significantly. The reduced shortfalls are seen as ZAR7.0 billion and ZAR16.8 billion in FY15/16 and FY16/17, respectively. This implies that these tax proposals are expected to generate an additional ZAR12.1 billion and ZAR15.0 billion in revenue over the next two fiscal years respectively – an additional ZAR17.0 billion is anticipated in FY17/18. There were no specific hints as to what these proposals might be, just that they would “improve tax efficiency” and “enhance the progressive character of the fiscal system”. The latter suggests a potentially steeper income tax ladder including a possible increase in the marginal tax rate, and perhaps also a hike in the effective rate of capital gains tax. With respect to tax efficiency objectives, proposals could include measures to address corporate tax avoidance. Judge Dennis Davis, in public comments earlier this week, hinted at recommendations to “detect and deter” tax-avoiding financial flows. Davis noted the significant gap between the nominal corporate tax rate of 28% and the effective tax rate paid by companies, which he pointed out was 18.2% between 2005 and 2011.

As part of government efforts to “reinforce sustainability”, it announced that the expenditure ceiling, as tabled in the 2014 Budget, would be lowered by ZAR25.0 billion. This is to be achieved via (i) a freeze on budgets of non-essential goods and services at FY14/15 level, (ii) withdrawal of funding for posts that have been vacant for some time, and (iii) reducing the rate of increase in transfers for public entities. Debt-service costs, which do not fall under the expenditure limited by the ceiling are seen rising steadily from ZAR114.5 billion in FY14/15 to ZAR149.7 billion in FY17/18. The estimates for debt-service costs over FY14/15 to FY16/17 are largely unchanged from the February Budget. There is perhaps some additional comfort on the expenditure side of the fiscal equation to be drawn from a large unallocated expenditure “buffer” of ZAR45.0 billion pencilled in for FY17/18. This buffer is explicitly designed as insurance against “economic and fiscal shocks”, although a portion could be used to fund “high-impact programmes”. In terms of the public sector wage negotiations currently under way, it was pointed out that budgets have been planned on the assumption that “cost of living adjustments will track consumer price index (CPI) projections”. Furthermore, it was stated that “any departure from the path of CPI-linked cost-of-living adjustments will require either a reallocation of resources …., or prompt a need to reduce government employment. It was also mentioned that as part of the proposed expenditure containment plans, “government personnel headcounts will be frozen for the next two years”, and there will be a multi-departmental review over the next year “to consider the permanent withdrawal of funded vacancies”. “Natural attrition will create space for new appointments”, and exceptions would be considered only for “critical positions”. Ratings agencies should view measures aimed at containment of government’s wage bill in a favourable light, and so should the SARB from a unit labour cost and thus inflation perspective.

Government financial support for Eskom was also addressed. Most notably, a direct allocation of ZAR20.0 billion was announced. Funds for this will be raised “though the sale of non-strategic assets”, with as yet no specific mention as to what these assets might be. Capital injections for Eskom and other SOEs will be raised in a way that “has no effect on the budget deficit”. We take it that this does not exclude the possibility that both revenue and expenditure estimates could be taken higher, with no net effect on the deficit. “In some instances, government will dispose of non-strategic assets to raise resources for financial support”.

The headline CPI was flat month-on-month in September; this pulled the y/y change in the measure down to 5.9% from 6.4% in August. This is the first time that headline CPI inflation has been below the target ceiling since February. The moderation was greater than Bloomberg’s consensus estimate of 6.1% y/y. SBGS Economist Kim Silberman’s forecast was 6.0% y/y. Core inflation (ex food & NAB, petrol and energy) fell to 5.6% y/y from 5.8%. The direct effect of the currency on CPI via petrol, clothing and vehicle prices moderated in September. Kim points out that second-round currency effects, which feed into inflation with a six to nine month lag are still muted. Second-round effects of the weak rand will remain a risk to core inflation for another three to five months, but are expected to moderate thereafter, due to global disinflation and more positive USDZAR base effects. Food inflation fell to 8.7% y/y from 9.5%, shaving 0.11 percentage points off August’s headline CPI. The slowdown in food was relatively broad based, but bread and cereals fell most, to 5.9% y/y from 7.7%, followed by meat. Meat prices finally succumbed to lower maize prices, falling fell to 9.4% y/y from 10.1%. Looking ahead, food inflation is expected to remain elevated in Q4:14, before moderating from December onwards. Kim anticipates that meat inflation will continue to slow, although there might be some stickiness in meat inflation as a result of farmers taking advantage of the low maize price and reducing the supply of meat to gain control over meat prices. Kim calculates that wheat usually takes about nine months to feed into the bread and cereals component of CPI, and consequently the increases in the wheat price experienced in Q1:14 may cause bread and cereals inflation to rise again in Q4:14 and Q1:15. Petrol inflation fell from 5.8% y/y to 1.1% y/y in September, shaving 0.27 of a percentage point (pp) off August’s headline CPI inflation rate of 6.4% y/y. Looking ahead, petrol prices rose 2c/litre in October, raising the petrol inflation rate to 2.7% y/y, which will add 0.09 of a pp to October’s inflation rate. Assuming Brent averages USD90/bbl in October, Kim calculates that the petrol price could deflate by 0.65% y/y, shaving 0.04 of a pp off November’s headline CPI inflation rate.

US CPI data, released yesterday, showed that inflation was up 0.1% m/m in both headline and core terms. For the headline figure, this was 0.1 of a percentage point above consensus, while the core data was in line with consensus. There was a reasonable fall in energy prices in September, but this was counterbalanced to some extent by a rise in food prices. In areas uninfluenced by the fall in energy, most prices in the main categories were up around 0.2% m/m or 0.3% m/m in the month. Steve Barrow (our G10 FIC Strategist) points out that the September core data suggests that the big miss we had in August (when prices were flat against calls for 0.2% m/m increase) was perhaps a one-off, and that there is not a more dangerous downward spiral in inflation than the market expects – at least not just yet.

Kicking off the release of provisional PMI manufacturing numbers for October from across the globe, we saw the reading for China come in at a healthy 50.4. Analysts had expected that the number would match September’s reading of 50.2. Later today, we see the release of provisional Eurozone PMI data. Steve notes that this data could be significant, as it comes at a time when the market is clearly fretting about another recession for the region in the second half of this year. So far, the signs for growth in Q3:14 have been bad, and today’s data could help to shape the way the market looks at Q4:14. With this in mind, the omens don’t look good, as the call is for the manufacturing PMI to slip below 50.0 to 49.9 from 50.3 last time. You have to go all the way back to June last year to find the last time that the manufacturing survey result was under 50. The skew on the 35-person Bloomberg survey is about even, but Steve’s bias is to the downside. The services survey is also seen down, albeit comfortably above 50.0 at 52.0, following a score of 52.4 in September. Here too Steve thinks that the risks lie to the downside and, if he’s right about this, the euro should drop alongside a fall in Eurozone bond yields.

The rand strengthened against the US dollar yesterday, closing at USDZAR11.00, compared with Tuesday’s close of USDZAR11.05. Rand appreciation against the greenback occurred despite dollar strength against all of the major crosses, as well as a largely weaker performance from the commodity and EM currencies we monitor for purposes of this report. The rand also strengthened against the euro, pound and the yen. The rand was the only commodity currency among those we cover that appreciated against the dollar on the day. Of the EM currencies we monitor for the purposes of this report, the ZAR and INR were the only ones to appreciate. The rand was the best performer in the EM currencies category. All of this suggests that rand strength was the result of positive domestic news – in particular, the creditworthiness benefit of a more disciplined fiscal stance outlined in the MTBPS. The rand traded between a low of USDZAR10.9949 and a high of USDZAR11.0200 intraday. Support from where the rand opened this morning sits at 10.9600, 10.9130, 10.8000, 10.7500. Resistance levels sit at 11.0800, 11.1650, 11.2450, 11.3100, 11.3550.

Commodity prices were mostly weaker. Brent, platinum and gold fell by 1.8%, 1.4% and 0.6% respectively. Copper rose by a modest 0.1%. The developed market MSCI fell by 0.2%, while the EM MSCI rose by 0.5%. The ALSI fell by 0.7%. The EMBI spread compressed by 4 bps, but SA’s 5yr CDS spread widened by 2 bps. The CBOE VIX index, a volatility based proxy for global risk appetite/aversion, climbed 11.1%.

Non-residents were strong net buyers of local bonds (ZAR1 256 million) on the day. Buying of bonds was seen in the 12+ (ZAR1 205 million), 1-3 (ZAR515 million) and 7-12 (ZAR574 million) year segments. Selling occurred in the 3-7 (ZAR574 million) year bucket. Bond yields fell on the day by between 12 bps (R186 and R214) and 17 bps (R203) into a bull curve steepening. The 3x6, 6x9 and 12x15 FRAs fell by 7 bps, 11 bps and 16 bps, respectively.

FI

Yesterday was an extremely good day for SA FI, with SA Headline CPI printing at 5.9% y/y (vs SBSA at 6.0% and consensus of 6.1%) and core CPI printing at 5.6% y/y (vs 5.8% consensus and 5.8% prior). We also saw a stricter budget from Finance Minister Nhlanhla Nene. We think that SA markets could take a step back after yesterday’s moves – the R186 has broken through the floor of our target range.

Yesterday’s budget is viewed as slightly positive for SAGBs, with a steeper curve expected. There are definite cutbacks in expenditure after 2014 real GDP growth was cut to 1.4%, from the prior forecast of 2.7%. Long-term debt issuance is forecast to be ZAR20.5bn higher in the current year than was forecast in February’s Budget, mainly due to the higher take-up of the non-competitive auctions and the additional USD700 million in foreign currency denominated debt that was issued. However, ZAR13.0 billion less is going to be issued in Treasury Bills. In the subsequent two fiscal years, ZAR14.7 billion less debt will be issued. This is an effective front-loading of debt issuance in the MTEF. However, there is no plan to increase the size of weekly auctions. National Treasury’s fiscal package is aimed at delaying some expenditure items, controlling the growth in the public sector wage bill and raising additional revenue through changes to the tax system that will be announced in February 2015. The changes to the tax system are expected to raise at least ZAR27 billion over the next two years. The MTBPS has budgeted for ZAR45 billion in uncommitted reserves by 2017/18, to be used to counter any fiscal or economic shocks.

The improved CPI figure saw headline CPI print inside of 6.0% for the first time since February’s 5.9%, while core decreased for the first time since August 2013. The improved inflation print came as petrol increased by 0.7% y/y (compared to +1.0% in August), and food and non-alcoholic beverages also decreased slightly with meat inflation showing a decrease. This takes YTD CPI average to 6.18%. The SARB has CPI averaging 6.2% for 2014, implying a 6.27% CPI average in Q4. It is significant that headline CPI is now back inside the target band, even if only temporary and will take some of the pressure off the SARB to act. Kim Silberman, SBGS economist, notes that “second-round effects of the weak rand will remain a risk to core inflation for another 3-5 months but are expected to moderate thereafter”. While petrol shaved 0.27pp off August’s headline number for September, the 2c/litre increase in October is expected to add 0.09pp to the print. Kim believes that food inflation “is expected to remain elevated in Q4:14, before moderating from December onwards”.

Turnover was ZAR19.76bn, almost the same as what we saw on Tuesday’s auction day. 39.6% of turnover came from the R186 (ZAR7.79bn traded). Offshore investors were net buyers of ZAR1.26bn of bonds, with some large bond selling in amongst the buying. Heavy buying was seen in the R203 (+ZAR538.9m), R186 (+ZAR425.1m), R213 (+ZAR305.0m), R214 (+ZAR228.7m) and R2048 (+ZAR185.6m). Significant selling was seen in the R208 (-ZAR364.4m), R204 (-ZAR206.8m) and R2032 (-ZAR133.3m). The curve bull steepened into a significant rally yesterday, as front-end rates were led by a -16.5 bp move in the R203 and back-end bonds parallel shifted lower by 12.0 bps. FRAs all moved lower, following the bonds. The 3x6 moved 7 bps lower, the 6x9 moved 11 bps lower ad the 12x15 moved 13 bps lower.

All bonds issued in Tuesday’s auction are in the money for non-comps and it is likely that the full 50% limit will be taken up in each bond.

US Treasuries rallied by small amounts yesterday, with the 10yr UST trading at 2.21%. SA was the outperformer amongst EM FI yesterday. The average move in EM was +0.17 bps in 5yr and +1.25 bps in 10yr. South African 5yr debt rallied by 13.1 bps and 10yr debt rallied by 11.9 bps. Russia, Mexico and Turkey led the moves weaker in both maturities, with Turkish 5yr debt weakening by 11.0 bps.

Latest SA publications

SA FX Weekly: Oil price plunge & currency market spillover effects by Marc Ground and Varushka Singh (21 October 2014)

Fixed Income Weekly: MTBPS week by Asher Lipson and Kuvasha Naidoo (17 October 2014)

Credit & Securitisation Weekly: Pick n Pay reports H1:15 results by Robyn MacLennan and Steffen Kriel (17 October 2014)

Credit & Securitisation Flash Note: Calgro M3 Holdings Ltd by Robyn MacLennan and Steffen Kriel (14 October 2014)

Fixed Income Weekly: Moody's still to act on SA by Asher Lipson and Kuvasha Naidoo (10 October 2014)

Fixed Income ALBI note: November ALBI reweighting; R2032 joins the index by Asher Lipson and Kuvasha Naidoo (10 October 2014)

Credit & Securitisation Weekly: S&P comments on Eskom package by Robyn MacLennan and Steffen Kriel (10 October 2014)

Fixed Income Trade Idea: Receive 3x6, 5x8 FRAs by Asher Lipson and Kuvasha Naidoo (8 October 2014)

South Africa: Credit: SA property sector: Challenging environment ahead for office and industrial sectors by Robyn MacLennan and Steffen Kriel (8 October 2014)

SA FX Weekly: Asymmetric risk by Marc Ground, Bruce Donald and Varushka Singh (6 October 2014)

Credit & Securitisation Monthly: Quarterly update – Q3 2014 by Robyn MacLennan and Steffen Kriel (3 October 2014)

Fixed Income Weekly: Revenue slightly behind, issuance well ahead by Asher Lipson and Kuvasha Naidoo (3 October 2014)