Mini-budget 2026: More revenue, less borrowing?

Jeremy: Stronger tax revenue should make a budget easier to manage, but it doesn't guarantee a lasting improvement in the public finances. Ahead of South Africa's mini budget, higher precious metal prices are supporting revenue collections. The question is whether that improvement reduces borrowing or is absorbed by additional spending.

And the global backdrop has become a lot more difficult. Conflict in the Middle East is adding to energy costs as well as inflation pressure. South Africa's growth outlook has weakened, and the Reserve Bank raised interest rates in September. So, this creates a difficult combination for National Treasury. Pressure on growth, pressure on spending, and a need to maintain the confidence of the investors who finance government debt.

Hello, I'm Jeremy Maggs. This is No Ordinary Wednesday, Investec's fortnightly podcast on the forces shaping business, markets, and economies.

Now on Wednesday the 21st of October, National Treasury will present the Medium-Term Budget Policy Statement. In this preview, we're going to examine what has changed since February and what a credible response would look like.

Joining me are Investec's Treasury Economist, Tertia Jacobs, and Chief Economist, Annabel Bishop.

Annabel, Tertia, to both of you, welcome back to No Ordinary Wednesday.

Jeremy: Annabel, let's start with the assumptions behind the budget, if we can. Since February, the outlook for growth, inflation, and interest rates has changed considerably. Which of those changes then, in your opinion, create the greatest difficulty for Treasury's fiscal plans?

Annabel: Hi, Jeremy. Yes, I think very substantial changes. We haven't seen such big ones for a while, really. I'm talking about on the inflation front, but of course also in terms of interest rates. Long-term interest rates matter as well, the cost of borrowing, the re-pricing of yields, but also GDP. And I think here we've seen quite a bit of disappointment.

From a GDP perspective, if we look at the forecast and the expectation last year of 1.4%, it came out at 1.1%. Now, this year is expected to be stronger at 1.6% and next year 1.8%. Those are also going to be revised down, and that's going to be closer to 1% for this year and1.5% for next year.

Let's not forget the El Nino, which could drop point2% of GDP. Overall, we are entering next year in a more difficult place. Inflation is higher from the Middle East war. In fact, we have seen the highest fuel prices historically come out now in October, and that's just going to place further upward pressure on inflation towards the 5% mark.

The reason I say that, is the under recovery. The daily figures we get from the Central Energy Fund are showing further big increases in fuel prices. And what that really means, it's just ongoing pressure on inflation. In fact, when you look at when the inflation target was instituted, formally adopted, if you will, Reserve Bank's only really achieved it once since then in February this year. It's been a difficult environment for them, but similarly as well, a difficult environment for Treasury.

When you have lower than expected GDP, it has a negative impact in terms of government revenue. When you have higher than expected inflation, and this is much higher than expected inflation, that also has a negative impact on GDP and of course as well impacts the fiscal ratios. But when you look at interest rates, not only is there upward pressure on interest rates at the short end, but we’ve also seen the repo rate rise, and it's likely to rise further.

There has also been this upward pressure globally on bond yields, and not just because of the major sell-off we've seen in global bonds. There obviously it stems back to worries around the US fiscal sustainability, high inflation and concerns over the AI investment boom and a reevaluation of the neutral interest rate in the US.

All of that really points to potentially higher for longer interest rates. And that's really seen our bond yields rise towards the 9% mark. It was below 8% this year and in the 7% targeting towards the 750 mark. So, what that's done is also had an impact on the cost of borrowing as well.

Now, of course, we felt this was temporary. We felt the Middle East war was temporary. We felt the impact was temporary, and we thought we would work our way through it and come through still in a better environment.

We started off with good fundamentals. We started off with low inflation, as I mentioned before, good growth last year, and cutting interest rate cycle. Sadly, all that has turned, and I think it's a bit difficult to really single out which is the most difficult for Treasury.

But I would say that the re-pricing of bond yields, the higher borrowing costs does make it quite a bit more difficult for the National Treasury. Particularly given that we were on a credit rating upgrade trajectory and our government finances were improving and have been improving. If you are borrowing now significantly higher, that puts a bit of an impediment in the way. Any type of crisis level, things would just become a little bit more difficult than they were.

Jeremy: Annabel, I'm glad you mentioned the Middle East and also El Niño. It's difficult to have a conversation these days without mentioning the weather. How much of the pressure on growth then is coming from that global environment, and how much principally depends on decisions that we can make ourselves in this country?

Annabel: I was having a look at economic growth last year. It came out at 1.1%. Interestingly, it would have been 0.7%, which is not a good figure, if we hadn't had the strong positive contribution from the agricultural sector, and that was a La Niña, above average rainfall year.

Now we're talking about an El Niño, a below average rainfall year. 2024 showed us what happened. In that year, we lost 0.3% in terms of GDP growth. 2024 came out at 0.5%. It should've been higher, around 0.8%/0.9%, if we hadn't had that agricultural impact.

So, where we're really going with this is not only will we not have the positive benefits of additional supported economic growth from a La Niña, we’ll, on top of that, have negative benefits from a El Niño. So that's why actually next year is significantly at risk.

Now, we can't say that's a domestic factor, nor is it global. It's just a weather phenomenon. But obviously what's happening globally in terms of the Middle East war is significant for us from an oil price shock. What we can control, Jeremy, is not having to import oil. We have got enormous reserves off the West Coast, and if we had better government policies, a better minerals and petroleum bill, we would have attracted the extraction of oil, like Namibia has done. Namibia sharing the basin with South Africa, busy draining the basin if you will, and we're not participating there.

Now, not having to import oil would severely improve our trade balance. It would severely improve our rand, the terms of trade, but, more importantly, have a positive impact in terms of inflation, GDP growth, employment.

All of these are factors we can control factors we can bring under closer scrutiny. Let's not forget the other areas we've talked about in many other podcasts, whether it's infrastructure and whether it's improving Transnet. We have seen significant improvement on the electricity front, but there are still governance issues. There are still areas that we can unpack and look at for improvements domestically. But yes, the biggest shock really coming through at the moment is the Middle East war and El Niño.

Jeremy: Tertia, let me bring you into the conversation, and let's look at that national balance sheet if we can. Is there a case at all for revenue coming in above budget? And if so, how confident are you that that might continue?

Tertia: I think there's a very strong case for upside surprise, and the main driver is going to be the increase in precious metal prices, gold and platinum, that's supporting mining profits. However, I don't think the impact is going to be as great as it was in 2021 and 2022 because the benefit also depends on production and your operating costs and the exchange rate.

We're looking at least 40 to 60/70 billion rand. Of course, what's adding to that is that your personal income tax and domestic VAT has also done quite well. The other dynamic here, and I think this is perhaps more the sustainability one, is that SARS efficiency gains to broaden the tax base is helping.

I think from that perspective there is more resilience in the system, but at the end of the day, the mining revenue boost is cyclical, and you do need that higher GDP growth.

Jeremy: Against that backdrop, how much of any additional revenue would you be comfortable building into future budgets rather than treating it or seeing it just as a temporary gain?

Tertia: I think we will only build in a portion. It looks like your precious metal prices average will be higher than what it used to be prior to when Russia invaded Ukraine. That will be more supportive, but whether we will return to the $5,000, $6,000 per barrel is an open question.

But as I've flagged, SARS is collecting about R100 billion per annum now. It looks like they're finding it more challenging to collect another R30 billion rand or so, and we know that the tax gap is about R400 billion rand or so, but they are working at it.

The other dynamic as well is in this kind of environment is that high inflation actually lifts your nominal GDP, which is helping. But then from next year when inflation starts to recede with the Reserve Bank quite committed to its 3% target, that lift will become slightly less.

Jeremy: Annabel, I'm going to try and phrase this question because one should be concerned, but how concerned are you about expenditure, and which spending pressures then would be high on your list?

Annabel: Just straight off the bat and before we discuss that, it's concerning because when you see a revenue overrun like we saw last year, suddenly virtually all of that R19/R20 billion was eaten up by additional expenditure that just flooded straight back in.

As Tertia says, another revenue overrun is likely, and yet how much additional sudden expenditure are we actually going to have? It eats it up again. It comes through things like the Mandlanga commission, it comes through other commissions and inquiries, it comes through additional contingency spending, if you will.

But essentially, all of these areas do just nullify the gains that we could make, then the more significant gains you could make in terms of fiscal consolidation. An area which continues to worry, I think, is the still proportionately very high spend on current expenses such as civil servants' wages and salaries. That's a very large expenditure area. We have got a very large number of civil servants, and here we're not necessarily talking about the ones in the front line such as our teachers and nurses and police, but more the administrative side and particularly the very high-end salary payments.

That's really where the pressure typically does come from, the extras and expenses. All of those things are a concern. But really, when you look at expenditure overall for South Africa, it's key for that to be the area where we start to reduce and not increase expenditure as we come into a budget.

The MTBPS hearing that is going to be additional expenditure allocations. We should hear there's been savings. We’ve actually spent less than we've projected. And in turn, with these revenue overruns, we're going to find ourselves in a better fiscal situation. We can be in line for more credit rating upgrades and lower borrowing costs.

Our bond deals could actually come down, and we could fare better. Globally we are already going against the norm to some extent where there has been this global bond sell-off and crisis. Obviously, we have been affected by negative investor sentiment, but improving our government finances here at home puts us in a much stronger fiscal position going forwards to weather shocks.

Jeremy: Annabel, to your point about servicing debt, which is a big part of our spending, what would convince you then that debt reduction is becoming more secure rather than just being pushed further into the future - kicking that proverbial can?

Annabel: Well, simply we just look at the figures. The debt to GDP ratio always gives you a sense of comfort or obviously a great sense of worry if it's pushed out. Last year and the year before, we did see, as I mentioned before, again, widening of additional expenditure, and that obviously creates concern because in the absence of increasing revenue, you then typically, and do, and that's what we did, revert once again to increasing borrowing.

Borrowing is quite damaging to continue to increase. We see fiscal slippage. We see widening of fiscal deficits. All of those are concerns. Now, as Tertia unpacked, we obviously have got this boom in precious metals, which is bringing us comfort in terms of the revenue front, but that obviously cannot be relied on.

Going forwards, we need to have stronger and more sustainable revenue streams which in turn are capable of servicing our debt and as well not instead put pressure on increasing debt because there's obviously sufficient revenue.

We saw that in the 2000s, very high GDP growth, and obviously we saw that in terms of infrastructure boom, and it's something we can replicate again. It comes back to better work being done domestically to follow growth, enhance economic reforms, and obviously being careful in terms of reforms that do come through which do not actually suppress economic growth.

That's really the area where you would obviously look for a successful improvement in terms of debt, and therefore your ability to service debt. Because ultimately, debt servicing comes from the revenue you get, and the costs of servicing debt come from how much debt you actually have.

Jeremy: Tertia, obviously listening to Annabel, that debt matters to the bond market. So, what then are investors recognising in South Africa's fiscal and monetary policy, and what remains outside of our control?

Tertia: That’s very important, Jeremy. The past two years have seen two very important developments. So, the one was the GNU that supports and are committed to fiscal sustainability. And the second one was the lowering of the inflation target to 3%. Now, even though we are in a high inflationary environment, the Reserve Bank has credibility, and there is belief that inflation will return to the target, even if it takes a little bit longer.

But the combination of these dynamics has then seen this re-rating in our bond yields, which has impacted debt servicing costs. So that's been a very constructive development. Previously, Treasury has lost some of its fiscal credibility because every year the numbers were revised higher. But it looks now like we may be on a slow path of reducing the debt to GDP ratio, which is still quite elevated to around about 79% of GDP.

But some of the revenue overruns that we have seen over last year has allowed Treasury to cut the size of the bond auctions. So, it's been a combination of dynamics that's helped the bond market.

Another dynamic in terms of the debt to GDP ratio, is with this expected revenue overrun, both the main budget deficit as well as the primary budget surplus are both likely to look better in the MTBPS. So, these are important developments that feed into credibility.

Jeremy: So, for someone watching the market, and here's a question that I guess all economists would love, can South African bond yields rise even while investors become more confident about the country?

Tertia: Yes. And that again, is a very important question because the American bond yields influence interest rates around the world. And with that repricing of American bond yields as well as European, UK, Japanese bond yields, it has exerted upward pressure on our bond yields as well.

Even though our yields have risen by more than 50 basis points over the past couple of months, the big driver has been external. So, what we have seen and what we look at very closely is the credit spreads and that so far is quite contained.

So, it's not as if the rise in the yield has been accompanied with a deterioration in the sovereign risk premium. That is basically relatively steady. It's more the upward pressure from the external side that's been the catalyst.

Jeremy: Tertia, you make the point that South African bonds have already repriced. So how much fiscal improvement is reflected in today's prices, and what could this mini budget still deliver that would change the case for allocating capital to South African bonds?

Tertia: So, there's some confidence in fiscal consolidation, and it's already reflected in the valuations. But we think in terms of the external uncertainties, we don't exactly know what the end state in the Middle East going to be. There's still uncertainty where American bond yields are going to settle. It makes sense for South African government bond yields to trade slightly cheaper than a fair value estimate that we assign to it.

I think what the MTBPS could do, and I think that is what they're going to focus on, is to continue to strengthen the investment case by showing that any additional revenue reduces borrowing. So that would be an interesting dynamic. How will that additional revenue be allocated?

There are quite big redemptions going into the end of this year and into next year, so they may also decide to run with slightly higher cash balances because of what we touched on in the beginning. There is some uncertainty about the sustainability of this windfall revenue that we're getting from precious metals.

I think they will be quite conservative with regards to that. And I think, very importantly is whether this debt-to-GDP ratio can stabilise and start trending lower. That will feed into rating announcements in November and May next year. So, there's quite a few interesting dynamics that we will be monitoring.

Jeremy: Annabel Bishop, let's look at the all-important fiscal anchor. What would a credible fiscal anchor look like in practice? And what should happen when government moves away from that commitment so that it changes decisions rather than simply adding another target to the budget documents?

Annabel: I think that a credible anchor is improved, its credibility is improved if it can be a flexible anchor. And here we're really talking about, and unfortunately, it's a bit technical, but you know, it's new, something that's going to be announced and something that's going to be unpacked, and essentially, you get numerical anchors, which are hard anchors. You cannot have your debt to GDP ratio going over 80%. There's a typical hard anchor.

People worry about that because what happens if you go, as you said, into a crisis like COVID or something else where you have to borrow more, and that is where it becomes tricky.

Then you have your principle-based anchor, which is really we are attempting to achieve this. And yes, there may be bumps in the road, but essentially our plan, our guidelines are that we would eventually get to the point where we achieve fiscal sustainability. That's also something which you have at the Reserve Bank as well if you want to look at inflation targeting. Yes, we want to meet the target, but at times when you obviously are experiencing such as an oil price shock or other crises, you will move away from it, and you will try and get back to it.

In other words, the Reserve Bank hasn't hiked interest rates by 5% to keep inflation at 3%. We've had that flexibility, and I think that flexibility is something which is perceived as something sensible for us when obviously crisis flexibility, it's called, when we move into periods that are just more difficult. We'll obviously unpack this and hear a lot more hopefully at the MTBPS, but it's something which will strengthen our fiscal path.

It'll give the credit rating agencies even more confidence in us. Already very high as Tertia outlined. It’s important just to provide those guidelines, those guardrails, so that we know what we are trying to achieve. I doubt there's necessarily going to be a timeline, but I think there certainly will be a greater colour added to it in terms of looking at deficits and of course looking at the primary deficit and surplus. We're already running at a primary surplus. I really think focusing particularly on the debt to GDP area, that's going to be paramount.

Jeremy: Tertia, talking about confidence, then there is some in the Reserve Bank's 3% inflation target, but we've already referenced energy costs, and that could delay the return to the target. So, the question is, how are investors weighing near-term inflation pressure against that longer-term commitment?

Tertia: So, that credibility is quite important because sometimes, when inflation is driven by temporary factors, investors can look through that. We are still in a period of uncertainty with the sharp increase in the fuel price in October, perhaps another one in November, and potential second-round inflation with, as I said, we don't know where the oil price is going to end.

I would say at this point, investors are balancing this high inflation dynamic against the credibility that the Reserve Bank will return inflation to the target. It is going to take longer, but we should start seeing some of the base effects of the high oil price start coming through in inflation round about the second quarter.

I think it does speak to interest rates staying higher for longer. So, the outlook remains very closely tied to the fortunes of the oil price and as I also alluded to earlier, the US Treasury yields.

Jeremy: So Tertia, try to look at all of this through the eyes of a ratings agency, if you can. What would demonstrate that an improvement in South Africa's public finances is structural rather than mainly the result of stronger commodity revenue?

Tertia: I would look at three things. The first one will be tied to the fiscal anchor, although it's expected to be principle-based. But within that, I think the first thing will be a sustained primary surplus, and then that your debt to GDP ratio declines under realistic assumptions. So, your GDP projections will remain quite important. And then finally, the stronger underlying growth dynamic.

I think the focus is it should be visible beyond mining taxes. Again, better tax compliance and the control of recurring spending, and then fewer unexpected demands from SOEs. We are seeing that government is financing SOEs more through the budget facility for infrastructure and pure cash injections that they had in the past.

So, to come back to this point, infrastructure reform really matters because that is the only way that we're going to expand the economy and widen the tax basis.

Jeremy: So let me just squeeze in a quick follow-up here, maybe talking about theatre versus actual performance. How much of that judgment then rests on projections in the speech, and how much of it requires evidence of delivery between the budgets? One senses the latter is probably more important.

Tertia: The projection provides the direction, but the delivery, as you point out, establishes the credibility. I think what has changed has been the GNU, where there is that commitment. There is an understanding that if you want to spend more, it must be neutral for the budget deficit, so there has to be tax increases.

We know that government is also committed to start to enhance savings, trying to improve the efficiency of spending as well, although there's still a lot of underspending taking place. So, I think they are trying to align things.

The fiscal anchor is going to help, but time will tell. We are in the early stages of that debt consolidation. The economy is still not growing rapidly enough. So, I think next year is also going to give us more clarity in terms of the sustainability.

Jeremy: Coming to the end of the conversation, and a question to both of you, and maybe let's test a less favourable scenario. Suppose the support from precious metals weakens. Let's assume that oil remains expensive and economic growth disappoints. And sorry to end the conversation on a downer, but Annabel, what becomes the most difficult fiscal choice in that environment?

Annabel: I think you know, Jeremy, it's higher taxes. And the reason I say that is you would obviously assume you should cut expenditure, because when your income shrinks, you should cut your cloth to fit your incoming monies. But unfortunately, that hasn't been the case with our government.

They've continued to spend, and that's when you tend to see the widening of the jaws occur. You tend to see your revenue flatten, but your expenditure really eats up what's there. Unfortunately, if that is the case, and we're not necessarily of the view that it will be the case, that we're going to continue to see elevated oil prices forever - but we do think that certainly into the course of next year, that that's likely, given the negative impact on logistics from the Middle East war, if nothing else.

But certainly, from a precious metals’ perspective, I think there is support there. So, we don't think this is necessarily a highly likely scenario. But sadly, when we do move into this tough environment, government does start to scratch around for higher taxes.

Jeremy: And Tertia then, as we end, where would you expect that pressure to become visible first in financial markets?

Tertia: I think where we could see it first is, you know, uncertainty whether the next move in your sovereign credit rating will be for an upgrade. So, there may be some disappointment. We may see some of our credit spreads widening again. So, I think that good news story that has supported this re-rating may fade.

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