“Houston, we have a problem”. It’s called Eskom, and plans for its rescue were a main focus of Finance Minister Tito Mboweni’s Budget 2019 Speech.
Although we’ve seen the Eskom crisis coming for a long time, it could now be entering a critical phase. It’s important for us all to understand the consequences if Moody’s, the last ratings agency not to have rated us as junk, does decide to downgrade us.
To that end, after discussing the financial risks we face generally, we consider the details of the Eskom crisis and of government’s response to it – will it succeed and has credibility been restored?
“It is not the critic who counts; not the man who points out how the strong man stumbles,
or where the doer of deeds could have done them better.
The credit belongs to the man who is actually in the arena,
whose face is marred by dust and sweat and blood; who strives valiantly;
who errs … but who does actually strive to do the deeds…” (Theodore Roosevelt 1910)
One of the shining lights of the country was the ability of Treasury to maintain fiscal discipline and not overburden the government with unmanageable debt. Since 2015, debt has risen quickly whilst tax revenues have slowed – debt to GDP (Gross Domestic Product) was 2.5% in 2015 but is now over 4% whilst tax collections will miss their 2018/19 target by R50 billion. Government debt to GDP was just over 40% in 2015 but is 56% now and is forecast to go above 60%.
All of these are alarming ratios but this was an unusual budget with the Eskom crisis the primary focus – the State-Owned Enterprise (SOE) only has sufficient funds to stay in business until April, has R420 billion in debt (R292 billion guaranteed by government) and cannot generate enough revenue to service this debt. The problem for government is that if Eskom collapses, then the economy basically stops – in the words of the President, Eskom is too big to fail. Yet its rescue is being closely watched by Moody’s – the only ratings agency not to rate South Africa’s debt as junk. Should Moody’s reduce us to junk status (and although they are scheduled to assess SA’s debt on 29 March they are expected to announce their decision after the May election) then off-shore institutions will be forced to sell R140 billion of government debt. This will have severe knock on effects, tipping our economy back into recession with a falling currency followed by interest rate hikes.
It is in this light that the Budget of Minister Mboweni should be judged.
In essence, the Budget is a holding operation in terms of tax changes as moves are made to deal with the Eskom crisis. The deficit to GDP will be 4.2% this year and will rise to 4.5% next year before declining in the out-years. Borrowing as a percentage of GDP will now breach 60% in 2024.
GDP will grow at 1.7% this year rising to 2.1% in three years. Inflation will rise from 4.7% now to 5.4% in 2022.
Government has taken R50 billion in cost cuts from the Medium Term three year budget – the main reduction is in government salaries with early retirement being offered to senior civil servants. Based on the assumption that 30,000 employees will take this up, the saving will be over R20 billion. The Minister emphasised that the government salary bill is unsustainable at 35% of government expenditure. Cuts were also made to overtime allowances, the government bonus scheme will be phased out and there is a salary freeze on senior SOE staff and cabinet and members of parliament.
Despite these savings the debt ceiling (a holy cow for Ratings Agencies) will be breached by R16 billion before coming back to within the ceiling.
Even before considering Eskom, these are sobering figures and the fact that the Minister laid them out starkly in an election year shows how the country cannot keep deferring the urgent issues it faces.
The President had already announced the intended split up of Eskom into three units: generation, distribution and transmission. This would allow greater management focus on the discrete parts of Eskom. The Minister said that R23 billion will be set aside for each of the next three years to assist the SOE with its reorganisation into the three units and to help with its debt service costs.
Eskom will need to save R20 billion in costs per annum over this period. Although Minister Mboweni only gave a three year outlook, the restructuring of the SOE will clearly be a long term effort and government will need to be committed for as long as it takes.
In order for Eskom to access the R23 billion, it will need to get the approval of a Chief Restructuring Officer (CRO) who will be appointed by Ministers Pravin Gordhan and Tito Mboweni. The CRO will operate within restructuring requirements to be announced by the President in the next few weeks. The CRO will be the eyes and ears of the government.
Other SOEs will need to appoint a CRO if they wish to access government funds – R6 billion has been provided in the Contingency Reserve for this.
It is as if the recent loadshedding has brought a new urgency in tackling the sizeable problems that Eskom and other SOEs present. What is refreshing about the approach taken by Minister Mboweni is that he and the President are breaking the mould of government thinking – the fact that the Minister openly questioned the rationale for many of these SOEs and called for breaking away from old Soviet paradigms shows we are moving into a new era.
Will this be successful?
There are enormous risks ahead, not least of which is the Moody’s rating decision. Moody’s are looking for a new credible approach to tackling Eskom and this is being laid out by the government. Trade Unions are already mobilising to fight the Budget and the reforms at Eskom. Perhaps the most encouraging aspect is that both Minister Tito Mboweni and President Ramaphosa seem up for the challenge.
If you strip Eskom out of the next three years, then there would be no breach of the debt ceiling and the debt to GDP ratio would not go above 60%. In fact the fiscal consolidation that Treasury has been desperately trying to instil since 2015 would be credible as the 2019 Budget would be in line with the projection of last year’s Budget.