Reserve Bank could lighten an efficient government’s load
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The severe economic consequences of the Covid-19 pandemic will cause an already bad fiscal situation to become even worse, with the government’s main budget deficit sure to reach more than double last year’s 6.7% of GDP. Equally, it should surprise no-one if the gross debt load races past 80% of GDP this year, and keeps rising to levels far exceeding the IMF's 70% “danger” flag for emerging markets.
Yet when finance minister Tito Mboweni committed in his June 24 supplementary budget to advance growth-boosting reforms and to rein in spending to tackle the ballooning debt burden, fixed-income investors were sceptical. This credibility failure is evident in the steep slope of the bond yield curve, indicating that investors’ concerns about public debt sustainability in the longer term have, if anything, increased. If actions by government cannot turn that around in time, there could well be a case for the Reserve Bank to play a role in bridging the credibility gap in the short term.
In the June budget the Treasury chose the pragmatic route of balancing support for economic growth with fiscal rigour. The budget deficit is projected to narrow from next year onwards thanks to planned cutbacks in recurring spending combined with the unwinding of special Covid-19 fiscal support and an improvement in tax revenue as the economy turns the corner. Further impetus ought to come from the favourable impact of structural reform on GDP growth. Consequently, the pace of debt accumulation should slow, ultimately resulting in the debt load peaking at about 90% of GDP by 2023. On the face of it, a workable plan.
So why have fixed-income investors not bought into the strategy? If they had, the slope of the bond yield curve would have flattened, not steepened. Instead, with long-dated bond yields having risen by more than shorter-dated ones have fallen, the yield gap, at 700 basis points, is now a good 70 basis points larger than it was before the supplementary budget. Instead of falling, sovereign credit risk, allied to large public borrowing requirements, has risen. Talk about a supposedly good fiscal story have fallen on deaf ears.
It’s not hard to realise why this is the case. Too often in the past SA’s creditors trusted the government to deliver on the Treasury’s pledges — ranging from reducing the wage bill to cutting wasteful spending, streamlining state-owned entities and accelerating reforms such as the licencing ...
Yet when finance minister Tito Mboweni committed in his June 24 supplementary budget to advance growth-boosting reforms and to rein in spending to tackle the ballooning debt burden, fixed-income investors were sceptical. This credibility failure is evident in the steep slope of the bond yield curve, indicating that investors’ concerns about public debt sustainability in the longer term have, if anything, increased. If actions by government cannot turn that around in time, there could well be a case for the Reserve Bank to play a role in bridging the credibility gap in the short term.
In the June budget the Treasury chose the pragmatic route of balancing support for economic growth with fiscal rigour. The budget deficit is projected to narrow from next year onwards thanks to planned cutbacks in recurring spending combined with the unwinding of special Covid-19 fiscal support and an improvement in tax revenue as the economy turns the corner. Further impetus ought to come from the favourable impact of structural reform on GDP growth. Consequently, the pace of debt accumulation should slow, ultimately resulting in the debt load peaking at about 90% of GDP by 2023. On the face of it, a workable plan.
So why have fixed-income investors not bought into the strategy? If they had, the slope of the bond yield curve would have flattened, not steepened. Instead, with long-dated bond yields having risen by more than shorter-dated ones have fallen, the yield gap, at 700 basis points, is now a good 70 basis points larger than it was before the supplementary budget. Instead of falling, sovereign credit risk, allied to large public borrowing requirements, has risen. Talk about a supposedly good fiscal story have fallen on deaf ears.
It’s not hard to realise why this is the case. Too often in the past SA’s creditors trusted the government to deliver on the Treasury’s pledges — ranging from reducing the wage bill to cutting wasteful spending, streamlining state-owned entities and accelerating reforms such as the licencing ...