Kemp Munnik, head of structured solutions at Bravura, offers his take on yesterday’s mid-term budget.
The new Finance Minister Malusi Gigaba delivered South Africa¹s 2017 medium term budget policy statement against the backdrop of glaring revenue shortfalls, ever-increasing debt to GDP and allegations of state capture at state-owned enterprises.
Gigaba’s first budgetary statement was keenly watched by local and international investors given the current high levels of uncertainty on an economic and political level in South Africa. Minister Gigaba¹s plans, as outlined in the medium term budget, were expected to give an indication of how the state intends to tackle fiscal challenges over the next three years.
The question on everyone¹s lips was whether the minister would stay on the fiscal course set by the previous Finance Minister (Pravin Gordhan), and exactly what Minister Gigaba would do to establish his own credibility.
A three-year view is significant because it provides insight into planned government expenditure and indicates expected tax increases that South African taxpayers have to face. It also informs decisions of the credit rating agencies about South Africa¹s fiscal stability.
The medium term statement provided a bleak picture of the economy, but provided very little in the form of clear proposals on the way forward.
Revision of growth forecast
The South African economy has slowed down significantly in recent years. During the last quarter of 2016 and the first quarter of 2017 it even retracted into negative territory. Minister Gigaba cut the 2017 February annual budget expectation of 1,3% growth for 2017, to 0,7% (followed by projected growth of 1,1% for 2018, 1,5% for 2019 and 1,9% in 2020.)
The medium budget statement recognises that this lacklustre growth is a result of a continued deterioration in business and consumer confidence, as well as perceptions of heightened risk as indicated in lower credit ratings, higher bond yields and sluggish investment. In 2016, gross fixed capital investment declined by 3,9%, with large decreases in mining and manufacturing. Capital investment is expected to decline by 0,6% in the current year.
Revenue and tax collection shortfall
There have been revenue shortfalIs in four out of the past five fiscal years, mainly as a result of disappointing economic growth. The cumulative shortfall is about R60bn. The 2016/2017 shortfall was R30-billion – the worst revenue performance since the global financial crisis.
Minister Gigaba has now announced a projected revenue shortfall of about R50,8-billion for the 2017 fiscal year. Tax revenue is projected to fall short of the 2017 Budget estimates by R69,3-billion in 2018/19 and R89,4-billion in 2019/20.
These substantial shortfalls substantiate comments that Treasury¹s tax buoyancy assumptions have been too optimistic in light of the weak outlook for growth, wages and corporate profitability.
Personal income tax collection has been affected by low bonus payments, moderate wage settlements, job losses and a slower expansion of public sector employment. Corporate income tax under-collections in the first half of 2017/18 have resulted from persistently weak growth and commodity price volatility. And weak investment and household consumption have led to a contraction in imports in 2016 that have adversely affected VAT and customs duties.
For the period of 2017/18, personal income tax has seen the most extreme deviation with a downwards revision of R20,8-billion (from R482,1-billion to R461,3-billion). Corporate income tax is R4,8-billion down (from R218,7-billion to R213,9-billion), dividend tax decreased R2,6-billion (from R34,2-billion to R31,6-billion). Value-added tax (VAT) collections is R11,4-billion down (from R312,8-billion to R301,3-billion).
Minister Gigaba was expected to look to other revenue streams, such as fuel taxes and higher sin taxes to claw back some of the shortfall. This did not materialise. His statement only mentioned proposals to finance national health insurance (NHI) through adjustments to the medical tax credit and the tax on sugary beverages which will be implemented in April 2018.
Given the lower revenue projections, deep expenditure cuts were going to be necessary to prevent the budget deficit from rising by the projected revenue shortfall. This did not happen.
Minister Gigaba announced that expenditure will grow by an annual average of 7,3%, from R1,6-trillion in 2017/18 to R1,9-trillion in 2020/21. The fastest growing category of expenditure is debt-service costs, which reach nearly 15% of revenue in 2020/21 and increasingly crowd out spending on services.
Minister Gigaba further mentioned that public-sector remuneration budgets pose a large and imminent risk to the expenditure budget, with the possibility that some national and provincial departments will exceed compensation ceilings.
Minister Gigaba has authorised R5,2-billion in bailouts to South African Airways (SAA) in only seven months. These bailouts have served to prevent the bankrupt airline from defaulting on its government guaranteed debt. An amount of R13,7-billion has now been allocated to forestall calls against guaranteed debt by the creditors of SAA and the South African Post Office.
The statement mentions that several others, including Denel, South African Express and the South African Broadcasting Corporation face liquidity shortfalls, and will likely require some form of intervention from government.
Minister Gigaba said that government remains committed to operating within the expenditure ceiling over the medium term. In the current year, however, the recapitalisation of SAA and the South African Post Office put the ceiling at risk of a R3,9-billion breach. Therefore, the government is looking to dispose of a portion of its Telkom shares to avoid a breach of the expenditure ceiling. Gigaba said the government would have an option to buy back the shares at a later stage. More details would be provided by March 2018.
Eskom is unable to borrow from the markets and has already drawn down R218-billion of its R350-billion government guarantee. Government has extended its R350-billion guarantee from 31 March 2017 to 31 March 2023 because of delays in Eskom¹s capital investment programme. The extension of the guarantee will allow Eskom to use the remaining portion to complete its planned capital expenditure programme.
Minister Gigaba has delved into the contingency reserve to the extent of R16-billion over the next three years in an attempt to make the books balance. This leaves government little room to maneuver if risks to the expenditure ceiling materialise.
A team of Cabinet ministers reporting directly to the President has been established to develop proposals to stabilise the national debt over the medium term. The team will work to ensure that the spending ceiling remains intact in the current year. A broader set of asset disposals is also under consideration, along with a restructuring of the portfolio of public assets to reduce risks posed by contingent liabilities. A new framework for the management of guarantees is being developed.
If government expenditure exceeds revenue, the difference must be borrowed, which adds to the level of government debt. Minister Gigaba said that the debt to GDP ratio will be more than 60% of GDP by 2022.
This implies that the government¹s burden on the economy (total government debt as percentage of gross domestic product) will increase. Certain economists have commented that SA has entered an unsustainable debt spiral.
The medium term budget statement states that government debt held by non-residents has risen from 4,4% of GDP in 2007 to 17,6% of GDP in 2017, cautioning that “a sharply negative shift in global investor sentiment towards South Africa could result in large capital outflows, with highly destabilising consequences for the economy.”
Stats SA has recently released statistics showing that poverty is deepening. As of 2015, one in four South Africans (25,2% of the population) lived in extreme poverty of less than R15/day, up from about one in five (21.4%) in 2011. Unemployment now stands at a staggering 27,7%, the highest level recorded since 2003. Moody¹s warned earlier this year that pressure to increase public spending in response to rising poverty and unemployment will complicate fiscal consolidation and challenge the state¹s reform commitment in the run-up to the 2019 elections.
Moody’s also noted that SA¹s levels of poverty, unemployment and inequality are higher than those in most other emerging markets, with 40% of the poorest households receiving only 8% of the country’s annual income.
The danger is that any slowdown in fiscal consolidation as a result of increased social spending would further weigh on business confidence, deterring investment and weakening longer-term growth.
The major credit rating agencies ¬ S&P Global Ratings, Moody’s Investors Service and Fitch Ratings ¬ were all keenly watching Gigaba¹s mini budget.
When Minister Gigaba was appointed in March, S&P and Fitch both cut the country to “junk” investment status, citing the potential for a change in fiscal course. When Moody¹s downgraded SA¹s sovereign ratings to the cusp of junk in June, it warned that the country could lose its investment-grade rating if its economic and fiscal strength continued to falter. These rating agencies will be analysing the mini budget to see whether the promises of the February 2017 budget speech of fiscal consolidation to reduce the budget deficit and contain the growth of public debt were met. They will in all likelihood focus mostly on issues surrounding SOEs.
The budget is perhaps a red flag for SA¹s credit rating. Last month Moody¹s expressed concern, noting that South Africa’s interest payments ratio exceeds the median of its peer ratings group. According to Moody¹s, more than a third of all sovereign defaults occur when countries allow fiscal imbalances to persist, resulting in unsustainably high debt burdens. When they are no longer able to service or reduce their debt, downgrades invariably follow.
Although ratings agencies will comment on the evening after the delivery of the mini budget, the official ratings update for Moody’s and Standard & Poor’s only takes place on 24 November. Ratings agencies would also pay close attention to the outcome of the ANC¹s December conference, the lead-up to which has been unpredictable.
Corporate South Africa will once again be holding its breath in light of the sobering news delivered in the budget. The opportunity to provide inspired fiscal direction has not been grasped.