PETER ATTARD MONTALTO: How the Treasury is holding it all together

The post-budget vibes have been odd. The yield curve has steepened and the rand has sold off somewhat, though part of it is due to markets overpricing the tail risks of a potential ANC-EFF coalition and not understanding the reaction functions of various parties after the elections.

We can certainly say that the markets have not reacted to the shock of the Treasury presenting a basically unchanged primary balance pathway to that of the medium-term budget policy statement — as it might otherwise have been “meant to”.

The poor Treasury can never seem to catch a break — though this is perhaps not a total surprise. I have long had this sneaking suspicion in response to the age-old question, “Why is the yield curve so steep?” that no matter what the Treasury does — even not issuing bonds altogether — it just wouldn’t move.

People think this sounds crazy, but the reaction of the market to the budget seems to prove the point. For all the endless curve disaggregation models I’ve built in my career, there is always a chunky underlying question that such analysis can’t answer.

“Ah, but Zimbabwe,” was the answer of choice before the global financial crisis. “Ah, but the long-run inflation risk” — pops up now and again (but you have to have some pretty far-out views of what has to happen to the Reserve Bank for this to be true).

“Ah, but political risk”. But this budget cemented a huge R66bn of cuts in the coming year versus previous baselines that departments and other entities were expecting, reinforcing the view that this cabinet is incredibly fiscally conservative in action, if not by design.

Then there is the one in play in recent years, “Ah, but growth,” which is half true, though needs to be thought about not in isolation but how the primary balance and real rates affect debt dynamics. Yes, growth is low. Yes, revenues are not great given that the Treasury is keeping to the same primary balance path for surpluses above 1% of GDP.

“Ah, but debt service costs.” True, but these are in large part a function of such a steep curve and market scepticism, that they must in some way be supported over time by higher primary surpluses.

“Ah, but state-owned enterprises.” Sure, all manner of things could go wrong with them, and Eskom could blow up tomorrow and need to be bailed out even more, but this cannot be the baseline. Extensive bailouts are already in the framework for Eskom but also for Land Bank and the rump end of the never-ending nightmare that is SAA. Transnet’s future bailouts are likely to be much smaller than Eskom’s and to be sequenced over several years. They can be forecast by the markets and so will hardly shock.

“Ah, but shocks — NHI! Basic income grant!” Sure, each of these things could happen, but the Treasury has so far held the line in the toughest season of all — pre-election — and National Health Insurance will be bogged down in the courts for much of the rest of the medium-term expenditure framework. Thinking the fiscus will blow up in this period due to National Health Insurance is just not rational.

The argument, “Ah, but they are cutting all the wrong things”, is a more interesting one, but the market doesn’t make it. There is a big problem here of the micro being deeply painful and not optimal because political space doesn’t exist to make choices — but this simply reinforces the point that holding the line on the macro-fiscal since there is no alternative, is all the more impressive.

I have a small amount of sympathy with the naysayers. I sit looking at my fiscal models and at what the Treasury has in the budget and something in my mind still struggles to accept that I am ending up as quite optimistic fiscally — even if my forecast path diverges a little below the Treasury’s.

People are missing several big issues. First, the budget was about holding the line on cuts intra-year, which the Treasury has done, and the latest January fiscal data released last week showed this, as it did about revenues being “OK”. Similarly, February Treasury cash data to be released this week are also likely to show the line is being held.

Second, the budget showed the realisation of cuts of about R66bn in the coming fiscal year that seem to have gone largely unnoticed in the markets since they were obscured by compensation increases. This is huge and occurred in an election year. People don’t read the Estimates of National Expenditure document (thousands of pages of it) but it shows the line-by-line detail of these huge cuts from this fiscal year to the next.

Third, the Treasury has taken out R178bn of issuance of long ZAR instruments over the coming three years, which is large (due to gold & foreign exchange contingency reserve account funds, or GFECRA, and the associated debt service costs savings. The market has focused too much on SA government bond (SAGB) issuance falling only slightly in the year ahead from R3.9bn/week to R3.75bn/week. This ignores all the other types of non-SAGB issuance the Treasury was planning and which have been scaled back to free up liquidity, which should support the yield curve moving lower.

Then there is GFECRA. The media reporting has often been over-sensationalised and sometimes simply wrong. “Raid”, “plundered” and so on. Quite how you can plunder yourself is not clear. This is the Treasury’s money. It is a liability from the Bank to the Treasury, which is being tapped without selling the underlying assets, necessitating some nifty, though not particularly complex, footwork.

“Ah, but it’s just a sticking plaster and doesn’t solve the underlying problems!” No one said it would. Not the Bank and not the Treasury. It is, however, a way to make some savings on debt service costs and help navigate a period of fiscal adjustment when large bailouts will eventually fall away.

“Ah, but this happened so fast.” Yes, the final stages have moved somewhat fast since the middle of last year, but there has been long-running albeit slow-moving concern and work in both the Treasury and Bank to resolve it since at least 2003, when they last looked at this issue.

“Ah, but it’s a slippery slope.” Sure, if you want to consider extreme tail risks, but nothing similar exists in terms of the liability relationship between the Treasury and the Bank. You need some pretty fruity changes to Bank leadership to see wilder things, which would then happen anyway regardless of GFECRA being done now or not. (The laughably left-of-field ideas that the Institute for Economic Justice was responsible needs quashing quickly…)

Eventually, after the data comes out, after the elections, after 2023/24 is kept on track and the 2024/25 cuts are realised, some reckoning will have to come for the yield curve. Though there will probably be something new to be bearish about. The Treasury may need to send shocks to the market on how it manages its bond issuances to dislodge current thinking, and the Bank starting to pursue a lower inflation target will also put paid to the, “ah, but long-run inflation” argument.

Eventually someone is going to get egg on their face, it just might be rather far-off egg.


Peter Attard Montalto leads on political economy, markets and the just energy transition at Krutham, a SA research-led consulting company.

This article first appeared in Business Day.