UPDATE 2-South Africa pledges unpopular wage cuts to rein in deficit

* Budget deficit seen at 18-year high in 2020/21

* Treasury seeks 160 bln rand in public sector wage cuts

* Trade unions have threatened protests over wages

* Rand lifted as traders bet on Moody’s reprieve (Adds quote, detail, context)

CAPE TOWN, Feb 26 (Reuters) – South Africa will cut its public sector wage bill to contain a rising budget deficit, Finance Minister Tito Mboweni said on Wednesday, setting the stage for a showdown with trade unions who threatened protests if pay was touched.

Mboweni’s pledge to cut 160.2 billion rand ($10.5 billion) from the wage bill over the next three years came as his ministry forecast the budget deficit would hit 6.8% of GDP in the fiscal year beginning in April, the highest in 18 years.

The pay cut promise boosted the rand, as traders bet it could help South Africa, the continent’s most industrialised economy, escape a painful downgrade of its last investment-grade credit rating, from Moody’s.

Mboweni said in an annual budget speech to parliament that South Africa was determined to rein in the deficit within the three-year budget framework and expressed hope that Moody’s would grant another reprieve at its next review, due in March.

“I don’t think they will re-rate us. I am positive they may give us a bit of a ‘klap’ which we will absorb. But I don’t think they will do anything untoward,” Mboweni told a news conference, using an Afrikaans word for a slap.

Fitch and S&P Global Ratings already assign the country’s sovereign debt “junk” status, and losing its last investment-grade rating could trigger a selloff of billions of rands of bonds, pushing up already high government borrowing costs.

South Africa has struggled to emerge from a deep economic slump in the two years since Cyril Ramaphosa became president promising sweeping reforms and pressure has built for his government to take corrective action.

The treasury now expects economic growth this year of just 0.9%, less than a previous forecast of 1.2% and far below the level required to make a meaningful dent in unemployment and poverty. Roughly one-third of South Africans are out of work.

Gustavo Medeiros at Ashmore Group, an emerging markets investment manager, said cutting the wage bill had not been priced in, and would be taken positively by financial markets.

“The public sector is way too bloated,” he added.

But in an indication of how unpopular the move will be with unions, one public sector group said on Wednesday it would “shut down government indefinitely” if Mboweni announced a freeze on wages, a less bold course of action than the one he took.

Mboweni said the government would negotiate with unions on how the wage cuts could be achieved. (Reporting by Olivia Kumwenda-Mtambo, Mfuneko Toyana, Wendell Roelf Additional reporting by Tom Arnold and Karin Strohecker Writing by Alexander Winning Editing by Joe Bavier and Catherine Evans)