Finance Minister Tito Mboweni’s Budget 2019 speech was forthright about the challenges facing the country and, while there were many bitter pills to swallow in the detail, the minister provided some good news (for rating agencies) on key subjects like Eskom and the public sector wage bill.
PwC Strategy& economists Lullu Krugel and Christie Viljoen unpack the detail of Budget 2019.
However, this cannot detract from the wide budget deficit and huge debt that the public sector is struggling with: PwC sees a high probability of Moody’s Investor Service downgrading South Africa to non-investment grade this year.
Key points:
- This year’s budget “addresses immediate risks to the economy and the public finances”.
- National Treasury expects GDP growth to rise from 0.7% in 2018 to 1.5% in 2019 and 1.7% in 2020.
- Tax revenue projections for 2018/19 have been revised lower by R15.4 billion (1.2%) compared to MTBPS estimates.
- No changes to personal income tax brackets in 2019/20, allowing for bracket creep – this will move some South Africans into higher brackets after they receive their inflation adjusted increases.
- National and provincial salary budgets cut by R27 billion over the next three years by encouraging early retirement.
- Consolidated expenditure is planned at R1.83 trillion in 2019/20, equal to a hefty 33.7% of GDP, and 1% higher than forecasted in October.
- Debt service costs will remain the fastest growing spending item.
- The fiscal deficit for 2018/19, is expected to end up at 4.2% of GDP, 0.2 percentage points higher than the October forecast and the same as PwC’s expectations prior to the budget.
- Planned fiscal deficit of 4.5% of GDP in 2019/20 shortfall will be wider than previously planned and the largest since 2012.
- Gross national debt projected to stabilise at 60.2% of GDP in 2023/24.
- R23 billion per annum for reconfiguration of Eskom under an independent Chief Reorganisation Officer (CRO).
- Rating agencies will be unhappy with the widening of the fiscal deficit, higher peak in public debt, and increased exposure to the financial woes at SOEs.
Improved economic growth outlook over the medium term
“It is time for us to sow the seed of renewal and growth,” says Mboweni.
The economic outlook has weakened since the tabling of the Medium-Term Budget Policy Statement (MTBPS) in October 2018. The National Treasury expects economic growth to rise from 0.7% last year to 1.5% in 2019 and 1.7% next year. These forecasts are marginally higher than the current forecasts from the International Monetary Fund (IMF) and the World Bank.
The downward revision of growth projections has been seen in most budgets over the past five years or so. Nonetheless, the state expects a decline in policy uncertainty, structural reforms and a more capable state to lift economic growth this year to the highest level in many years. This is an arduous task given a weaker outlook for the global economy.
The minister is looking at a recovery in business and consumer confidence to stimulate the local economy. The reforming of State Owned Enterprises (SOEs) is also expected to be a contributing factor in supporting healthier economy. The Minister was correct in saying that, following a decade of economic weakness, there are some positive signs for South Africa. However, budget since budget speeches have been over-optimistic about the pace of economic growth, and hence, PwC expects economic growth of 1.4% in 2019.
Growth-enhancing measures include a relaxing of international visitor visa regulations, expanded eligibility for the youth employment tax incentive scheme, nearly R20 billion in industrial business incentives, and President Cyril Ramaphosa’s promised Infrastructure Fund. Disappointingly, there was little additional information forthcoming on this fund beyond what was already known.
Revenue boost from no change in personal income tax brackets
Gross tax revenue projections for 2018/19 have been revised lower by R15.4-billion (1.2%) compared to MTBPS estimates. Around half of this is due to higher-than-expected VAT refunds, with the remainder contributed to lower tax collections, driven to a large extent by disappointing tax collections from companies and personal income taxes.
In response to ongoing concerns over the underperformance of collections by the South African Revenue Service (SARS), Minister Mboweni indicated that the Davis Tax Committee would investigate the gap between revenue collected that taxes that should be paid.
Budget Speech 2019 acknowledged that several tax rates have increased in recent years to deal with revenue pressure. The Minister indicated that improvements to the revenue collecting capabilities at SARS should, in the short-term, result in raising revenue more effectively than raising tax rates further. As a result, there were no changes to personal income tax brackets in 2019/20 or value-added tax (VAT).
There will be no inflation adjustments to personal income tax brackets. This will result in some South Africans moving into higher tax brackets (if their income is adjusted higher to take inflation into account) where they will pay tax at a higher rate than before. This is often referred to as “bracket creep”.
The budget includes the regular upward adjustment in taxes on alcoholic beverages (excluding sorghum beer), tobacco products and the fuel levy, with the latter increasing by 29c per litre for petrol and30c per litre for diesel.
Reducing the public wag bill to curb expenditure growth
Minister Mboweni acknowledged what most local economists have been saying for a long time: that the public sector wage bill is unsustainably large. As a result, he is cutting national and provincial compensation budgets by R27-billion over the next three years.
Most of these savings will come from early retirement options for older employees, with details to follow in coming weeks. Furthermore, Members of Parliament (MPs), provincial legislatures and executives at SOEs will not be receiving remuneration increase in this year. Public entities are also encouraged to freeze the salaries of workers earning more than R1.5 million rand per annum in the 2019/20 fiscal period.
These savings are R5 billion more than the amounts set aside for Eskom.
From a function perspective, all the major expenditure items listed in the graph below will see a reducing in sending in the coming year compared to plans laid out by the MTBPS. The only exceptions are increase funding for the contingency reserve (in case of requests for financial support from SOEs) and payments for financial assets.
Of particular interest to many South Africans when considering where the country is currently standing with regards to land reform, is the plan to lower land reform and restitution grants by a combined R2-billion in 2020/21 and 2021/22.
A key focus area in this year’s budget speech is the financial support that has been set aside for Eskom and the Infrastructure Fund. Because of these and other changes, the 2019/20 fiscal year is expected to see consolidated expenditure of R1.83 trillion, equal to a hefty 33.7% of GDP. Debt service costs will remain the fastest growing spending point, forecast to grow by an average of 10.7% per annum during 2019/20-2021/22.
According to the Minister, the budget remains pro-poor and redistributive, and social spending (e.g. housing, schooling and education) remains the key focus of the current administration.
Wider deficit and rising debt will worry rating agencies
The finance Minister did not make much reference to the budget deficit in his speech. This is surprising, given that at a planned 4.5% of GDP, the 2019/20 shortfall will be wider than previously planned and the largest since 2012. This confirms the precarious state of public finances – and the many good news items in the Budget Speech 2019 cannot patch over the wide crevice. This will likely not be positively received by rating agencies. PwC is forecasting a budget deficit of 4.7% for 2019/20.
A wider deficit in 2019/20 and 2020/21 (compared to plans laid out by the MTBPS) signals an increased borrowing requirement to fund this gap. Gross national debt is now projected by the National Treasury to stabilise at 60.2% of GDP in 2023/24 compared to a ratio of 59.6% suggested in October. This breaks the 60% psychological threshold that the state has been attempting to avoid for quite some time.
SOEs must appoint Chief Reorganisation Officer (CRO) to access debt guarantees
Government will set aside R23 billion per annum to financially support the reconfiguration of the power utility. This money is contingent on the appointment of an independent Chief Reorganisation Officer (CRO) at Eskom to deliver on the reconfiguration and other recommendations made by a presidential task team about the matter. The minister made it clear that the state will not take over any of Eskom’s debt.
Eskom used an additional R50 billion of the R350-billion state guarantee during the current financial year. However, the minister announced that the guarantee system – whereby the government guarantees an SOE’s debt borrowings against non-payment –would in the near future include a prerequisite for appointing a CRO at the borrower towards the undertaking of a full financial and operational review. Furthermore, the state is considering ending guarantees for debt used in funding operational processes. An alternative would be to find strategic equity partners to provide the financing.
Rating agencies likely to be unhappy about deteriorating fiscal metrics
While Minister Mboweni did not spend any time in his speech talking about ratings agencies, they are important (albeit a small set of) stakeholders. The sovereign has been downgraded to sub-investment grade by S&P Global Ratings and Fitch Ratings due the deterioration in its fiscal position over the past decade. If rating agency Moody’s Investors Service were to also downgrade the debt to sub-investment level, South Africa would be removed from the Citi World Government Bond Index.
This would prompt asset managers and pension funds to sell billions of rands worth of domestic bonds. This would sharply increase the cost of debt and pressure the exchange rate.
Rating agencies are likely to be unhappy with the widening of the fiscal deficit, higher projected peak in public debt, as well as increased exposure to the financial woes at SOEs. The deterioration in these metrics have been a steady trend in recent years so it would not come as a shock. However, rating agencies set thresholds and do peer comparisons to determine whether a country has shifted lower in its creditworthiness to borrow internationally If S&P, Fitch, and especially Moody’s feel this is the case for South Africa, the results could be another bitter pill to swallow.
In spite of steps to address the Eskom crisis, as well as the public wage bill, PwC sees a high probability of Moody’s downgrading South Africa to non-investment grade this year.