<strong><em>By: Nazmeera Moola, Deputy MD, Investec Asset Management</em></strong>

Finance Minister Tito Mboweni delivered some very hard messages in his maiden Budget Speech yesterday.  None of it came as a surprise.  However, as the ANC has shied away from facing any of these issues over the last decade, the real surprise lay in their willingness to do so just months before a national election.

<strong>Deficit worsens as Eskom is included</strong>

While it was widely expected that a significant allowance would need to be made for Eskom, the view was that government would take over a significant portion of the debt. Contrary to expectations, National Treasury have taken this through normal expenditure, thus adding roughly 0.4% to the main and consolidated budget deficits in each of the next three years.  Without the Eskom charge, the main budget deficit would have narrowed to 4.2% of GDP in financial year 2019/2020 instead of the rather scary 4.7% published.

National Treasury is unwilling to take on the debt as they believe it would incentivise the wrong behaviour.  The purpose of the support is to ensure that Eskom can pay its debt; they will not be able to use it to make operational payments.

National Treasury has therefore made it clear that they are confronting the challenge posed by Eskom head-on.  After consulting rating agencies, the advice they received was that “if you are going to do something, do it transparently.”

<strong>Will it be enough to appease the ratings agencies?</strong>

While National Treasury indicated that they had engaged with rating agencies on Eskom ahead of the Budget, we believe a far more plausible plan on Eskom’s turnaround is required in the next few weeks to prevent Moody’s from moving SA’s outlook to negative at their March update.  Moody’s noted after the State of the Nation Address that the SA government taking on Eskom liabilities (either directly or indirectly by providing support) would only be viewed as neutral if it were accompanied by an immediate cost-reduction plan that could be implemented imminently.  This needs to be produced.

<strong>Focus on using the private sector</strong>

Driven by the absence of other options, the government is increasingly focusing on using private sector skills and funding to provide infrastructure.  Given that the latest renewable round saw electricity pricing reasonably below that of estimated Kusile costs, future generation will be built by the private sector.  The effect of splitting Eskom into three divisions will remove the dependence of South Africa’s generation from the utility.

<strong>Prioritisation</strong>

National Treasury believes there is room to cut the wage bill by R27bn over the next three years. These savings are needed to fund a number of measures aside from Eskom, including a rise in the Youth Wage Subsidy, provision for some gradual roll-out of National Health Insurance and a R3.5bn increase in SANRAL’s budget.  We need to see proof that Government can deliver on this promise. The undertaking by members of parliament and provincial legislatures and executives at public entities not to receive a salary increase in this financial year is a good starting point.

<strong>Budget exposes fiscal decline over the last decade</strong>

The Budget today is a reflection of ten years of poor budgeting and kicking the can down the road.  The best encapsulation of this is the deterioration at state-owned companies.  In 2011/12, state-owned companies averaged a return on equity of 7.5% – not high by private sector standards, but more than adequate for a state entity.  By 2017/18, this had deteriorated to -0,3%.  Government was losing money across its portfolio of companies.

In conclusion, while the National Treasury has done a heroic job of trying to rein in expenditure by cutting the wage bill and making it clear that any transfers to Eskom (or any other state-owned entity) would require significant cost savings, there is simply not enough detail to gain a comfort level on whether these savings will be achieved.  We will need to monitor developments closely in the coming weeks and months.