National Budget Speech 2020: What to expect and how to trade

When is the National Budget Speech?

Finance Minister, Mr Tito Mboweni will deliver the National Budget Speech on 26 February 2020.

What to expect from the National Budget Speech?

Compiling the South African budget has become an even more arduous task as the Finance Minister faces an already delicate balancing act of trying to lower debt, reduce the deficit, stimulate growth and contain expenditure, whilst still trying to appease ratings agencies, unions and the government.

The future of state-owned enterprises

State-owned enterprises (SOEs) have for a long-time produced a hole in the wallet of the South African fiscus. Markets will be awaiting further detail on progress and planning at the meeting, as suggested by president Cyril Ramaphosa at the State of the Nation Address (SONA).

Eskom remains the biggest threat to the South African economy with load shedding and rising electricity tariffs having contributed significantly and negatively to growth, possibly having helped moved South Africa into a technical recession in quarter four (Q4) 2019. Eskom is to continue load shedding over the next 18 months (or more). Independent power procurement by municipalities has been suggested and will be necessary to support economic growth in the country.

Governments guarantees on Eskom debt amount to over R300 billion, while Eskom debt exceeds R450 billion, creating a R150 billion post-Treasury guarantee shortfall which still needs servicing and attention.

Of a lesser but still significant burden to the state and requiring further address are: South African Airways (requiring R5.5 billion from Treasury) and SA Express, both currently in business rescue, Denel and SABC turnaround plans and Prasa (placed under administration).

The budget deficit necessitates more taxes

Shortfalls in collections amidst a weakened economy will necessitate increased taxation. Over the last few years tax increases have primarily been applied to capital gains, sin, personal income, value added and dividend withholding taxes, as well as higher fuel levies and contributions to the Road Accident fund.

While sin taxes are all, but a given each year, the pressured oil price might see Treasury use this as an opportunity to further increase the fuel levy.

Personal income tax could be raised marginally for high income earners, while the capital gains inclusion rate could be increased as well.

An increase in value added tax (VAT) is perhaps one of the easiest ways to tax a broader audience and a likely collection tool to be implemented at 1% more than current (15%).

An increase in corporate taxation appears unlikely in lieu of the global trend of lowering these rates to encourage investment, where corporate tax levels are already quite high on a comparative basis.

Expenditure

Increasing debt levels have increased debt servicing costs to absorb more of the spending budget. Government needs to contain expenditure, despite these increasing costs, whilst still finding room to support infrastructure development and economic growth. Social development plans such as the National Healthcare Insurance initiative, need to be addressed in terms of feasibility and implementation.

Moody’s Investor Relations

Moody’s Investor Relations will be monitoring the speech closely before reviewing South Africa’s sovereign credit rating’s (expected to be released on 27 March 2020). The group has recently downgraded its economic growth forecasts for South Africa, as well as lowered the ratings outlook from stable to negative. Should the agency lower South Africa’s local currency credit rating by one notch, it would label localised debt as sub-investment grade (junk), incurring a forced removal from major bond indices and selling of SA debt.

However, it should be considered that South African bond yields are trading at elevated levels on a both a historical and global comparative, suggesting that a ratings downgrade may already be largely priced in.

Learn more about how the financial markets react to the Budget Speech.

How to trade the Rand during the budget speech?

The short to medium term trend bias for the USD/ZAR remains up as the 20 moving average (MA) trades firmly above the 50MA. Currently we see the USD/ZAR has broken out of the near-term range between the R14.75/$ and R15.10/$ levels.

A break above the R15.10/$ mark suggests further weakening of the rand against the US dollar, with R15.45/$ the next upside resistance target. Traders who are not already long USD/ZAR might look at a pullback towards the R15.10/$ level for long entry if afforded the opportunity. While not displayed on the above chart, a break above the R15.45/$ level would call for further gains with R16/$ the next upside resistance target.

The above graph shows the USD/ZAR (blue) compared to the South Africa Financial Index (black line). The arrows on the chart show the inverse relationship between these two securities, whereby rand weakness is accompanied by weakness in the financial sector.

A negative assessment of the upcoming budget speech is expected to see a softening of the rand, which would be negative for local financial counters as well as retail and the broader industrial sector, reliant on domestic consumption (SA Inc.). Inversely a stronger ZAR would be considered positive for these counters.

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