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Ballooning Debt Costs Crowding Out Police: South Africa Credit

October 26, 2012

South African Finance Minister Pravin Gordhan

Pravin Gordhan, South Africa's finance minister. Photographer: Chris Ratcliffe/Bloomberg

South Africa’s debt-service costs, the fastest growing area of government expenditure, are threatening to undermine spending on police, housing and schools as falling tax receipts add to deepening strains on the budget.

Interest payments on government debt will be 88.9 billion rand ($10.2 billion) in the year through March 2013, second only to welfare payments, according to the National Treasury. Costs will climb 8.9 percent annually over the next three years, compared with 8.2 percent in total spending. Debt will climb to 41.3 percent of gross domestic product this fiscal year from 39.4 percent last year, versus 8.3 percent for similarly-rated Russia, 35.4 percent for Mexico and 54.2 percent for Brazil.

Finance Minister Pravin Gordhan is being forced to finance a rising debt burden, which may lead to spending curbs on social and infrastructure programs, as he seeks to shrink the deficit, forecast to be 4.8 percent of GDP this year. Moody’s Investors Service and Standard & Poor’s cut the nation’s credit rating in the past month amid concern about government finances. Bonds fell after his budget yesterday, sending yields on benchmark nine-year securities to the highest in more than a week.

“This budget reinforces our underweight stance on local bonds,” Esther Law, the London-based director of emerging- market strategy at Societe Generale SA (GLE), said by phone yesterday. “I don’t think the risk of a downgrade is any lower than before. If anything, the budget is underlining the rating agencies’ worries.”

‘Upper Limit’

Gross government debt is set to peak at 42.7 percent of GDP in the year through March 2014, up from a February estimate of 42.4 percent. Domestic bond sales will reach 157.8 billion rand in the current fiscal year, more than the 151.4 billion rand projected in February.

“We are very close to the upper limits of what we can fund through debt,” Lungisa Fuzile, director-general of the Treasury, said in an interview in Cape Town yesterday. “In the short term, if you have growth slowing, tax revenue slowing, your deficit widens a bit. You can’t just slam on the brakes.”

Yields on the government’s 6.75 percent bonds due March 2021 rose two basis points, or 0.02 percentage point, to 6.70 percent at 12:35 p.m. in Johannesburg. The yield has climbed 26 basis points since reaching a record low on Sept. 26. The rand slipped 0.2 percent to 8.7578 per dollar. The currency has dropped 7.6 percent this year, the second-worst performer after Brazil’s real among 16 major currencies.

‘Draining Resources’

Debt-service costs “are draining resources that could be spent on productive investment,” the Treasury said. Spending on interest compares with a national government budget of 122.2 billion rand for social welfare, 58 billion rand for police, and 47.8 billion rand for education, according to budget documents. The country’s nine provinces each spend additional money on education and policing.

“It is absolutely crucial” to stabilize debt levels, Rian le Roux, chief economist at Old Mutual Investment Group, South Africa’s largest private money manager, said by phone from Cape Town. “Ultimately if it is not, you are going to see interest rates go up a lot and then it becomes a problem and you have to work very hard at fiscal consolidation.”

Slower economic growth following a series of mining strikes will curb tax revenue, widening the fiscal gap. The shortfall will reach 4.5 percent next year, up from an earlier forecast of 4 percent, Treasury said.

Increased Spending

Overall government spending will rise 8.5 percent to 1.15 trillion rand in the year through March 2014 and increase 7.9 percent the following year, in line with the government’s targets in February. Revenue, which will probably be 4 billion rand lower than projected at 901 billion rand this year, will increase 9.5 percent and 11 percent for the next two years, respectively.

The government will continue with its program of refinancing short-maturity bonds with more expensive, longer- term debt to avoid a repayment crisis in the near term, the Treasury said. The plan, together with increased issuance of long-term debt in the Treasury’s weekly bond auctions, have boosted the gap between three-year notes and securities due in March 2036 to the most in four years, according to data compiled by Bloomberg.

“We’d like to see them stop lengthening the maturity of bond issuance,” Madalet Sessions, a fixed-income analyst at BoE Private Clients in Cape Town, said by phone before the mid-term budget was published. “That is unattractive to the asset market. Indirectly they are signaling that they don’t like discipline.”

Lost Output

Moody’s cut the rating on the government’s debt by one level to Baa1 on Sept. 27, citing increased pressure to boost social spending as job losses mount. Strikes that began at Lonmin Plc (LON)’s Marikana mine on Aug. 10 spread to operations owned by Anglo American Platinum Ltd. (AMS), Gold Fields Ltd. (GFI:US) and AngloGold Ashanti Ltd. (ANG), costing 10.1 billion rand in lost production, according to the Treasury.

S&P, which lowered South Africa’s rating to BBB on Oct. 12, highlighted increased policy risks as the ruling African National Congress pushes programs to address poverty and unemployment. About 16 million people, or a third of the population of 50.6 million, receive welfare grants.

Fitch Ratings, which has South Africa’s BBB+ rating on a negative outlook and is due to complete a review early next year, said the nation is lagging peers in reducing debt.

Further Weakening

The mid-term budget “shows evidence of further weakening in the country’s public finances,” Fitch analysts Richard Fox and Carmen Altenkirch said in an e-mailed statement today. “Failure to deliver projected fiscal consolidation continues to erode one of the sovereign’s key rating strengths compared with its peers.”

The yield premium of South African rand debt over 10-year U.S. Treasuries widened almost two basis points to 485 basis points yesterday, the biggest gap since Oct. 16, according to data compiled by Bloomberg.

“I don’t think that this is a budget that will placate the credit rating agencies,” George Glynos, an analyst at ETM Analytics, said by phone from Johannesburg yesterday. “I would have liked to see a bit more fiscal discipline. They’ve got to do more with less.”

To contact the reporter on this story: Robert Brand in Cape Town at

To contact the editor responsible for this story: Vernon Wessels at

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