Dave Mohr & Izak Odendaal, Old Mutual multi-managers, unpack yesterday’s Budget speech.
In our preview of the Budget Speech, we outlined four requirements for avoiding a downgrade to junk status. How did the 2016 Budget Speech measure up?
A Budget based on realistic macroeconomic assumptions? Mostly.
The Budget is a projection of expected tax revenue, spending and borrowing over a three-year horizon. If not based on realistic macroeconomic assumptions, it immediately loses credibility. National Treasury cut its real economic growth forecasts in October 2015 to 1.7% in 2016 and 2.6% in 2017, but these were still too high. It now expects growth of 0.9% in 2016, 1.7% in 2017 and 2.4% in 2018. The 2017 and 2018 forecasts might still be on the optimistic side. The inflation forecast was lifted from 6% in 2016 to 6.8% and from 5.9% in 2017 to 6.3%. Weaker economic growth means tax revenue growth can be expected to slow, while higher inflation increases the cost of inflation-linked spending (particularly wages, which consume 35% of overall spending).
A credible strategy to reduce the budget deficit without pushing the economy into recession? Largely.
At a minimum, the budget deficit projection from the October Medium Term Budget Policy Statement (MTBPS) needed to be improved on, despite much weaker expected tax revenue growth. This was achieved, which is important for ratings agencies and investors. The 2015 deficit is more or less as expected at 3.9% but the projected consolidated budget deficit for 2016/17 is now 3.2% of Growth Domestic Product (GDP), 2.8% for 2017/18, and 2.4% for 2018/19. Treasury expects to run a primary surplus (budget balance before interest payments) this fiscal year – for the first time in years. This should stabilise the government debt-to-GDP ratio at around 46.2% by 2017/18.
On the tax revenue side, taxpayers will feel relieved. Finance Minister Pravin Gordhan wants to raise an additional R18 billion this year but is tapping small increases in different sources of revenue, rather than a big-ticket increase. Effective Capital Gains Tax (CGT) for individuals will increase from 13.7% to 16.4% (through the increased inclusion rate), raising an additional R950 million in the coming fiscal year. Higher CGT rates for companies will raise another R1 billion. The usual sin tax increases will raise another R2.2 billion. New taxes include a sugar tax (from next year), a tyre levy, a vehicle emissions levy and a light bulb tax, but these will not raise much extra revenue. The 30 cents per litre (or 12%) fuel levy hike will raise an additional R6.8 billion but should not leave consumers in a worse-off position in the short term, as the over-recovery on the fuel price is currently almost R1 per litre.
There were no changes to personal income tax rates but only R5.5 billion relief was provided for fiscal drag (inflation pushing taxpayers into higher brackets), compared to R8.5 billion last year.
The much-debated increase in Value-Added Tax (VAT) did not materialise, nor did any “wealth tax”, but these are still under review. The Budget noted that R15 billion per year in additional tax revenue would have to be raised in the following two fiscal years, without describing how this will be done.
On the spending side, the expenditure ceiling, which limits allocations to departments and provinces, has been reduced by R10 billion in 2017/18 and R15 billion in 2018/19 from the October levels. It will still grow by around 7% per year in nominal terms over the next three years, which is only slightly ahead of inflation. The emphasis on, and achievement of, greater spending discipline is very encouraging. This is done through cutting waste, centralising procurement and reprioritising. For instance, the new travel and accommodation policy is expected to reduce spending by R1.6 billion over the next three years. Every bit helps.
The very generous (one might say unaffordable) public sector wage increase means other areas of spending will be cut. The wage increase also eats deeply into the contingency reserve – Government’s rainy day fund. With Agri SA lobbying for R12 billion in drought relief and students demanding free education, a bigger contingency reserve would have been handy. However, growth in the wage bill will be capped to 7.4% over the next three years by a hiring freeze on managerial and administrative staff.
Social grant increases will be slightly below inflation this year.
Debt service costs remain the fastest growing item in the Budget, with increases of 11.4% per year expected over the medium term, increasing to R178 billion by 2018/19. This highlights the importance of getting debt under control.
The combination of spending cuts and tax increases will be a headwind for the economy. However, by themselves they should not tip the economy into recession. This was probably the motivation for not pushing fiscal consolidation further.
Concrete steps to reduce the burden of underperforming state-owned enterprises on government finances (and the broader economy)? Not really.
Other than noting that a common governance framework is being drawn up and that a process of stabilisation and rationalisation is underway, the Budget was disappointingly thin on detail with regard to state-owned enterprises. It noted that Government would look at opportunities to allow the private sector to get involved in infrastructure projects and also in South African Airways. Details on these measures are keenly anticipated.
Confidence-building economic policy reforms that will boost economic growth expectations? Yes, but …
Given the lack of “fiscal space” Government cannot do much to support the weak economy cyclically or over the short term. But it can contribute towards structurally raising the economic growth rate. Stronger growth over the long term is needed to improve the sustainability of government debt and social spending. Growth is therefore the key variable for the ratings agencies, perhaps more so than the actual budget deficit.
The Minister announced few new measures, hoping instead that better implementation of existing measures (infrastructure upgrades, industrialisation incentives, some red-tape reduction for small businesses and the Operation Phakisa “ocean’s economy” project) will do the trick.
It is encouraging that Government and business leaders have more actively engaged over the past two months than at almost any time over the previous decade. Only good can come from that.
A long and an uncertain road ahead
Leading up to the 2016 Budget Speech, expectations that Finance Minister Pravin Gordhan would deliver a “good” Budget rose strongly. However, there was always the risk of disappointment.
It is worth noting that in the current context, a “good” Budget from the perspective of investors is a “bad” Budget for the proverbial man in the street, as it would involve increases in some tax rates, little tax relief and reduced government spending in key areas. But in the longer run, the interests of investors and taxpayers align. A downgrade to sub-investment grade (or junk status) hurts everyone, and ever-increasing government debt means there is less money to spend on other important areas. Taxpayers and consumers, especially higher income earners, actually came off lightly this year.
So was the Budget “good” enough to avoid our foreign currency sovereign debt rating going junk? The projected deficits are encouraging but there is little detail on the growth side. The Budget can probably postpone the dreaded downgrade but not avoid it. To avoid it completely will require careful and consistent implementation but also a bit of luck. Global conditions will also have to become more favourable to emerging markets and the commodity rout will have to stabilise. It is therefore likely to be a long and an uncertain road ahead.