S. African Debt Climbs as Gordhan Pledges Spending Curbs

South African Finance Minister Pravin Gordhan will struggle to keep government debt under control even as he pledges to stick to spending targets.

Gross debt will climb to 48 percent of gross domestic product in the year through March 2017 from an estimated 43 percent last year, the National Treasury said in its mid-term budget report released in Cape Town today. That’s mainly due to rising debt costs and tax receipts falling short of targets.

While Gordhan, 64, is maintaining spending limits and curbing wage growth, allowing him to meet this year’s budget deficit target, borrowing will surge in the next three years. That raises risks for South Africa as credit rating companies such as Moody’s Investors Service warn of another downgrade and the U.S. Federal Reserve scales back its monetary stimulus, boosting bond yields.

“Up until now the minister has not really managed to do what he has promised in terms of the deficit and that is why the ratings agencies are still punishing us about it,” Lullu Krugel, an economist at KPMG in Johannesburg, said by phone today. “The intention is good, but the actual outcomes are not achieved. The pace at which borrowing is rising is frightening.”

The rand gained to 9.7714 against the dollar as of 6:54 p.m. in Johannesburg from 9.8144 before Gordhan began his speech. The yield on the 2026 bond rose 1 basis point, or 0.01 percentage point, to 7.71 percent.

While Gordhan forecast a lower budget deficit for this year, that’s mainly due to a restating of the figures, in line with international reporting standards, to include extraordinary receipts, such as profit on bond sales and foreign-currency transactions.

Restated Targets

Based on the new format, the shortfall is estimated to reach 4.2 percent of GDP in the year through March, unchanged from last year, Gordhan said. The deficit is forecast to narrow to 4.1 percent, 3.8 percent and 3 percent respectively in the next three fiscal years.

In February, Gordhan forecast a shortfall, excluding extraordinary receipts, of 4.6 percent of GDP this fiscal year, down from 5.1 percent last year. Calculated on this basis, the deficit for this year was 4.5 percent of GDP, unchanged from last year, according to the Treasury.

Moody’s cut South Africa’s credit rating in September last year to Baa1, the third-lowest investment grade level, while Standard & Poor’s and Fitch Ratings followed by cutting a further step. Moody’s and S&P hold a negative outlook on South African debt, indicating a greater chance the rating will be downgraded than raised.

‘Historical Legacies’

“We are running a sustainable fiscal ship and hopefully the ratings agencies will do their homework and recognize that in a very turbulent environment, and one in which we’ve got huge historical legacies to overcome, we actually are keeping a fairly good 19-year record and good fiscal management in South Africa,” Gordhan told reporters in Cape Town.

Gordhan trimmed his forecast for economic expansion this year to 2.1 percent from 2.7 percent as strikes in mining and manufacturing disrupted output and global growth remains weak. The economy will probably expand 3 percent in 2014 and 3.2 percent the year after that, according to the Treasury.

Konrad Reuss, head of S&P’s sub-Saharan African unit, said it’s still too early for the ratings company to take a different stance on the nation’s debt.

‘Very Tricky’

“With regard to the budget this year and next year, there are certain implementation risks which still should be reflected in a negative outlook,” he said in a phone interview. “The economic situation is very tricky, very challenging.”

The rand has lost 14 percent against the dollar this year, the worst performer among 16 major currencies tracked by Bloomberg.

In the February budget, Gordhan had forecast gross debt to reach 45 percent of GDP by 2015/16 from an estimated 42 percent last year. The International Monetary Fund said on Oct. 1 that while South Africa should target a debt ratio of about 40 percent, a ceiling of about 50 percent to 60 percent may be sustainable.

South Africa’s debt levels compares with 80 percent in Hungary, 59 percent in Brazil and 36 percent in Mexico.

“The increase in debt levels is not a problem if you compare South Africa with some other countries,” Johann Els, an economist at Old Mutual Investment Group of South Africa, said in a telephone interview from Cape Town. “The fact that the deficit is getting smaller means we are putting a damper on the growth in debt.”

Investor Sentiment

South Africa’s reliance on foreign investors to finance the budget deficit has increased in recent months, adding to the nation’s economic risks, according to the Treasury.

Investor sentiment is volatile and capital allocation “is likely to shift as the U.S. monetary authorities taper their asset purchase program,” it said.

“There is no magic in those ratios,” Lungisa Fuzile, director general of the Treasury, said in an interview in Cape Town. “We would prefer to keep these ratios as low as possible but in the context of a counter-cyclical fiscal stance you don’t really target them. You tolerate a bit of a deterioration.”

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