Budgets have never been so crucial for South Africa and Nigeria

By Rafiq Raji, PhD

Published by BusinessDay Nigeria Newspaper on 23 Feb 2016. See link viz. http://businessdayonline.com/2016/02/budgets-have-never-been-so-crucial-for-south-africa-and-nigeria/

South Africa’s finance minister Pravin Gordhan is scheduled to present his country’s budget for the 2016/17 fiscal year on 24 February, one month before the beginning of the fiscal year on 1 April; a tradition the country has rarely trifled with. Its continental rival, Nigeria, does not have a coherent budget two months into the country’s 2016 fiscal year. So, even as markets decry the current state of South Africa, Nigeria is doing so much worse. South Africa’s central bank is also doing an excellent job with the country’s monetary policy. The same cannot be said of the Nigerian central bank. Still the two countries’ budgets would be a major determinant of how much progress their economies make this year. In the South African case, a conservative budget is what is needed to placate key stakeholders, especially ratings agencies. Nigeria needs to be prudent as well. However, Nigerian authorities have opted for the type of fiscal expansion unprecedented in the country’s history. Even then, Nigerian authorities have not been able to produce a workable document. That job has now been unwittingly delegated to the Nigerian legislature, which instead of debating the substance of the budget is now overwhelmed with the task of reconciling the figures and producing a coherent document in the first instance. It is pertinent to note at this stage, that the economic headwinds facing both countries are similar. One country has been forced to follow the path of relative prudence because it is more integrated into the global economy. Incidentally, Nigerian authorities are also learning that it would not be enough to simply talk of wanting foreign direct investments without providing the type of certainty that investors need to make capital allocations to their country. It is now abundantly clear that short of painful and palpable economic consequences from the authorities’ dated policies, Nigeria’s President Muhammadu Buhari may not see the missteps he has made adopting some of them; his naira policy in particular. He may not have to wait too long. Economic growth for the first quarter of 2016 would likely be poor. Much of the momentum economic agents were banking on to power the economy this year was the budget. And now even that does not inspire confidence. By the time it is finally passed by the country’s legislature in March – hopefully and that is if things run smoothly – most private capital allocation decisions dependent on the fiscal outlook would probably only begin to bear fruit in the third quarter of 2016 and even then perhaps only marginally. Nigeria should probably brace up for growth of about 3 percent or less this year. In the South African case, growth would likely be zero or near zero percent in 2016. Drought effects, likely tighter than planned monetary policy, and a likely ratings downgrade to junk status are some of the reasons why. Likely continuing student protests and probable labour unrest during the course of the year are also weighing factors.

After the relatively cool reception to the State of the Nation address (SONA) by South Africa’s President Jacob Zuma on 11 February, there are still great expectations about finance minister Gordhan’s proposals. Keen watchers would be ratings agencies that are all but decided on a likely downgrade of the country’s credit ratings. There is a high probability Standard and Poors (S&P) would downgrade South Africa’s rating to junk status in June. Having been behind the curve relative to its rivals, Moody’s would almost certainly downgrade South Africa to one notch above junk status at some point this year. Actually, Moody’s dilemma is likely whether a two-notch downgrade straight to junk might not be more appropriate; in part to correct the image it has been lenient hitherto. There is some resignation to the junk scenario among officials, albeit they have been putting on a brave face, fervently making the case that the country could avoid a downgrade. It is expected that finance minister Gordhan would make some major cuts in expenditure and probably raise taxes. Judging from President Zuma’s speech, it may not be far-reaching enough. There is not yet the political will to make the kind of aggressive, unpopular moves that are needed to turn the country around. There might actually not be the political space for them. For instance, authorities need to sell some state-owned enterprises that continue to weigh on the country’s finances. Instead, authorities are actually setting up new ones. In his SONA speech, President Zuma announced the setting up of a state-owned pharmaceutical company to supply vital drugs to public hospitals that are currently procured at exorbitant prices from the markets. This is likely popular with the masses but sub-optimal for the fiscus. South Africa should actually be letting go state-owned enterprises, not setting up new ones. Another much more effective cost-cutting measure that would resonate with ratings agencies would be to cut the size of government. The announcement by President Zuma that the number of capitals should be reduced to one from the current two – Pretoria and Cape Town – is not far-reaching enough. The number of government ministries needs to be reduced as well and the consequent redundancies dispensed with.

Even when such far-reaching measures are taken, there is the issue of growth. Forecasts for 2016 are already tending towards zero. Moody’s ratings recently announced it expects the 2016 headline to be 0.5 percent this year. As the South African Reserve Bank (SARB) may need to be much more aggressive to curb inflation – higher than expected in January at 6.2 percent year-on-year, it would likely revise downwards its 2016 growth forecast of 0.9 percent at its next monetary policy committee (MPC) meeting in March. Markets expected the inflation headline to be a little below 6 percent in January. On 19 February, SARB deputy governor Kuben Naidoo signaled – rather directly and probably aimed at testing market reaction – that the central bank may need to implement much more aggressive monetary policy in ‘a short space of time’ if it is to bring inflation back within target. This is being interpreted to mean it could hike rates further in March – after only just hiking its benchmark rate by 50 basis points to 6.75 percent in January – and perhaps at each of the remaining MPC meetings in 2016. The downside to this appropriate stance would be growth. With drought effects worsening, zero growth in 2016 is becoming increasingly likely. A ratings downgrade amid tighter monetary policy makes negative growth in two consecutive quarters – a recession – this year highly likely. Analysts have already begun echoing this possibility. So, it may matter little in the short-term what measures Mr Gordhan announces this week. Still, were they to be far-reaching enough, it may improve the country’s ratings later in the year.

Political risk is also a major drag. Apart from the diminishing power of the incumbent president, an increasingly aggressive opposition is gaining ground. Student protests on fees, free education, and racism are symptomatic of much more entrenched problems. Increasingly effective, opposition parties like the ultra-leftist Economic Freedom Fighters (EFF) are leaping on the opportunity. The ruling African National Congress (ANC) would be forced to respond. For instance, ‘FeesMustFall’ protests in 2015, resulted in upward adjustments to the budget allocation of the government’s financial aid scheme for students. Above-wage labour settlements are also inevitable compromises the ruling party may be forced to accommodate as it tries to hold together its tripartite alliance with the Congress of South African Trade Unions (COSATU) and South African Communist Party (SACP). These potential settlements are a great source of concern for the SARB. The aggregation of these risks – drought effects, exchange rate pressures, political upheaval, above-inflation wage settlements, higher interest rates, slowing Chinese economy, and dull global economic growth – is overwhelmingly credit negative. Having downgraded countries like Brazil, Saudi Arabia, Bahrain, Oman for less, S&P cannot afford to ignore these risks based on positive signaling from authorities alone. There is a credibility issue for all parties. On the one hand, South African authorities are faced with the task of rebuilding their lost credibility – and it would be foolhardy to think four months to June would be adequate to restore it. Ratings agencies face their own credibility issues as well. Of the three major ones, S&P has proved prescient and much more diligent. Going from its no-nonsense drift thus far this year, it is highly unlikely it would not downgrade South Africa in June. Moody’s faces a bigger credibility problem. In light of what is now known, its current rating for South Africa is not an accurate reflection of the country’s credit-worthiness. It needs to restore that credibility. This is likely what has motivated its aggressive turnaround to the downside on the country. Recent warnings by Moody’s in so short a space of time are ominous. One expects it would downgrade South Africa by at least one notch soon. What South African authorities should probably focus on is a subsequent recovery. The advice to authorities would be that they embark on much more comprehensive structural reforms now. One is not sure if the resignation or removal of President Zuma would help douse some of the negative sentiments. Irrespective of who is president however, if he or she does not implement the type of painful, unpopular and aggressive structural reforms needed to return South Africa back to a sustainable growth path, then the current headwinds may herald the beginning of a heartbreaking and downhill journey towards stagnation.

In the Nigerian case, there is a clear need for President Buhari to get his house in order. He is failing on the economy. Year-on-year economic growth in the first quarter of 2016 would likely be lacklustre – could be negative even – due to constrained economic activity in the quarter thus far. There is an urgent need for President Buhari to constitute a strong economic management team. It is also abundantly clear that there needs to be a change in leadership at the Central Bank of Nigeria (CBN). There are sufficient grounds for asking Governor Godwin Emefiele to resign. Although his current term would not expire for another two years at least, the malfeasance under his watch during the Jonathan administration is solid ground for him to be excused. Considered objectively, his probable culpability in the whole affair potentially taints the advice he offers the president. Two of the most recent CBN governors have come out publicly to criticize this current CBN leadership. If former governor Chukwuma Soludo is not considered apolitical, could this also be said of erstwhile top banker, Emir Muhammadu Sanusi? It is highly unlikely that Emir Sanusi’s relationship with an international financier would prevent him from airing objective views. The Nigerian president seems ideologically entrenched to the argument that since the country does not export much, a cheaper naira has limited advantages. However, the need to devalue the naira in the Nigerian case is largely based on an anti-corruption and economic diversification argument. How the president does not get this is mind-boggling. This column highlighted previously the political challenge the president potentially faces were he to devalue the naira. Going from commentary among humble people in the country, there is now an awareness that the naira’s value is higher than the official rate. Even sachet water vendors are now conversant with the exchange rate. It therefore borders on arrogance if the president continues to insist on his really stale argument. Frankly, one gets the sense the Nigerian president does not like being ‘guided’ on what to do.

On the 2016 Nigerian budget, it is hugely embarrassing that such monumental errors and numbers manipulation should be associated with the Buhari administration. Although, this is not by the president’s design, as leader he is responsible. More importantly, it is now abundantly clear there need not be as much spending as earlier planned. Various estimates making the rounds suggest 600 billion to 1 trillion naira in budgeted spending could be done away with. There need not be as much borrowing therefore. And the budget deficit needs not be higher than 2 percent of GDP, 1 percent is actually much more apropos. The excuse that the reduced number of ministries and new zero-cost budgeting approach are responsible for the shoddiness is simply disingenuous. Nigeria’s Auditor-General has already come out publicly to say the envelope-system was used in preparing the 2016 budget now being corrected by the Nigerian legislature. And by the way, why did the reduced number of ministries not create redundancies? Reducing the number of ministries without dispensing of the staff seems counter-productive. What benefit then? Cost efficiencies from cutting the number of ministries can only be garnered if it helps reduce the public wage bill significantly. These efficiencies are not discernible from the budget precisely because the gains from the cuts have been limited. With monetary and fiscal policies in such shoddy form amid a continuing oil price slump and strained finances, S&P would likely put Nigeria on a negative outlook or even a downgrade in March. As Nigeria plans to tap the Eurobond market, what was already an unfavourable market would be even harsher on the country for reasons of the authorities’ own doing. As things are at the moment, the cost advantage of borrowing internationally is increasingly diminishing. There seems to be recognition of this by authorities as earlier in the month, Reuters news agency reported plans by authorities to postpone its planned Eurobond non-deal roadshow in March. Although Nigeria’s finance minister Kemi Adeosun debunked this claim to a rival news service, Bloomberg, it is highly likely Nigerian authorities now recognize – as they should – that a Eurobond issue might not be optimal at this time. In sum, the lesson in one’s view for the current Nigerian government is one of caution. The Nigerian president needs to up his game on the economy. He is running out of time. He has to ensure that these avoidable mistakes do not occur again. To this end, the necessity of establishing a highly powered economic management team cannot be over-emphasized. One would advise that the team be dominated by independent members who should not enjoy any form of remuneration from government. And there are highly capable and experienced people who would gladly take up these roles should they be invited. President Buhari should also probably stay at home more. Else, he may wake up one day frustrated at his little progress and with no time left.

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