South African reforms pale against remaining challenges

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      By Emerging Markets Debt Team, Eaton Vance Management

      Pretoria - The newly released South African budget contains some hopeful promises of reforms, but does little to instill confidence that they will be implemented. The country is struggling with declining revenues, rising expenditures, higher debt and failing state-owned enterprises (SOEs) - most notably the electric power utility Eskom, which is being bailed out by the government.

      President Cyril Ramaphosa took the reins last year from Jacob Zuma, who is standing trial for corruption after a nine-year presidency that left the economy and government institutions in shambles. Last year, the country suffered a recession for just the second time since 1994. State wages and compensation remain the largest category of spending, accounting for a third of consolidated expenditure - a level that the finance minister has described as "unsustainable."

      The Eskom bailout helped push the budget deficit projection for 2019-2020 to 4.5% of GDP, up from estimates of 4.2% in October. Public debt is officially 56% of GDP, up from 28% in 2008.

      During his first year in power, Ramaphosa has taken some important steps. He has replaced Zuma appointees on the boards of SOEs, in the justice department and tax authority. He has pushed an initiative to raise capital investment in the country, and has pledged to reduce government spending, break up Eskom, promote market competition and release state-owned land for development.

      With Ramaphosa facing elections in May and August, success in implementing reforms may hinge on the size of the mandate his ruling African National Congress (ANC) garners. There also may be obstacles from infighting within the ANC - after 25 years in power, many members have a vested interest in the status quo. Ramaphosa gained leadership of the ANC by a margin of 179 votes out of 4,500 delegates, so his base of support within the party is slim. Organized labor has also proven capable of being a powerful roadblock to reform.

      The Global Income team long has been critical of South Africa's policies and fundamentals, as we have consistently witnessed budgets getting revised in a negative direction and growth underperforming - this may just be the latest example.

      Bottom line: The new budget and Ramaphosa's reforms represent steps in the right direction. But, much follow-through needs to take place before optimism is more appropriate than skepticism.