Kathy Gibson is at PwC’s pre-budget review in Johannesburg – South Africa is sitting in the dark this week as loadshedding hits hard, and PwC sees little to cheer us up as it unpacks its predictions for this year’s budget.
In fact, Lullu Krugel, chief economist at PwC, expects that the international ratings agencies will downgrade the country during this year unless we are able to drive meaningful growth.
The organisation expects the country to see a cyclical upswing in economic growth. However, significant structural challenges that will keep the growth rate below 2%.
The World Bank and IMF are predicting growth up to 1,8% by 2021, with PwC’s predictions coming in at 2,3%.
2018 ended at 0,8% growth, with 2019 expected to rise to 2,3%.
Some of the growth enhancing measure that should be taken include details on investment initiative, including the infrastructure fund; and emphasis on stimulating investor confidence; details on how the reallocation of funds will reignite the economy; and a commitment to structural changes on the supply side of the economy.
When he presents the budget on 20 February, Finance Minister Tito Mboweni will be looking to take a practical approach to increasing economic growth. Two proposed solutions that the minister recently shared with media include an agreement where the private sector deploys skilled people to government, as well as arrangements that would facilitate skilled immigration.
Minister Mboweni is expected to report back on the successes so far of the stimulus and recovery plan launched in September 2018. The aim of the plan was to reallocate government spending towards activities that will have the greatest impact on economic growth, domestic demand and job creation.
The stimulus package centres on shifting R50-billion in the 2018/19 budget from non-performing projects to areas that can boost the economy and provide jobs and establishing an infrastructure fund to boost labour-intensive investment. This will likely especially benefit people living in townships as well as rural economies, women and the youth.
Krugel points out that South Africa’s sovereign debt has been downgraded to sub-investment grade by S&P 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.
To appease credit rating agencies, Minister Mboweni will need to talk to three specific issues: fiscal consolidation; reforms in SOEs; and measures to lift economic growth. By effectively outlining a path forward for South Africa’s fiscus, the minister will be able to satisfy credit rating agencies and would steer the economy away from a sub-investment grade.
Business confidence remains low, correlating closely to policy uncertainty – and both have slipped again after the initial “Ramaphoria” last year.
Business activity remains low, Krugel adds, with a number of factors feeding into this situation.
Foreign direct investment (FDI) is also performing badly, largely as a result of bad governance, political instability and uncertainty about property rights. These factors have all worsened over the last years, leading to South Africa scoring badly in the areas that investors care about.
“We need to get certainty back about those, and communicate clearly to the outside world about it,” Krugel says.
On the positive side, last year’s investment summit saw significant announcements and helped to build confidence in South Africa. This will help to attract investment from outside the country, and also give companies within the country more confidence.
The projects already announced should create and sustain about 165 000 jobs, Krugel adds.
Although the budget deficit is growing in line with other BRICS countries, South Africa’s deficit isn’t backed by strong economic growth, she says.
In 2018/19, PwC estimates that we will miss the predicted deficit figure of 4%, coming in at 4,3%, and this is expected to grow in 2019/20 to as much as 4,7%, compared to the 4,2% forecast.
Government debt as a percentage of GDP has doubled over the past 10 years, from 27% to 56%. “This is where concerns form the ratings agencies are coming in,” Krugel points out.
She says debt accumulation should lead to better infrastructure and increase economic growth rather then the ineffective spending on SOE debt that we have seen to date.
The restructuring of SOEs has already brought about many changes at the top level of major entities such as Eskom, Transnet, South African Airways (SAA), the South African Broadcasting Corporation (SABC) and Denel. Minister of Public Enterprises Pravin Gordhan has led this restructuring of the boards at the five parastatals and those boards, in turn, have put in place new leaders and top management structures.
Government’s exposure to SOE debt has risen from R160 billion in 2011 to R308 billion in 2017. In 2017, Eskom accounted for 73% of total government exposure to SOE debt. Eskom tariffs have roughly doubled over the past seven years; despite this, Eskom still exposes the state to high levels of debt. Furthermore, the power utility is seeking additional tariff increases of over 15% per year as a way to maintain its going concern.
Credit rating agencies, in particular, have raised that the SOEs remain a risk to the sovereignty of the South African state. Forecasts by S&P Global Ratings see government guarantees for SOEs debt rising to R500 billion by 2020, which will represent around 10% of GDP.
Minister Mboweni will need to indicate the path forward for South Africa’s SOEs. Tangible effort will need to be given to a strategy that gives a clear perspective to how government can drive SOEs’ developmental mandate while ensuring they remain financially sound. The fate of employees at these public entities is a sensitive issue that must be considered.
With tax collections the only way that government generates revenues, the R27-billion downward revision in the mini-budget is of concern.
Kyle Mandy, tax policy leader at PwC, points out that we can expect tax revenues to be at least R10-billion less than even this estimate. “Since October, revenue collection has deteriorated significantly,” he says.
The major culprits are corporate income tax and a slowdown in personal income tax. These are partly offset by VAT and customs duties.
“It’s not looking good.”
As at December, tax revenues are up just 7,6% against a forecast of 10,6%. Corporate tax has shown negative growth, personal tax is up 7,6% VAT has increased 12,4%, customs is up 13,7% and the fuel levy growth is 6,5%.
“What this means for this year’s budget is that, if we have lower tax collections, the shortfall gives us a lower base to start with,” Mandy explains.
Mandy doesn’t believe we will see significant tax increases in the upcoming budget, partly driven by a need to drive compliance and the fact that there is little room to make further increases.
There could be small increases in personal tax, in the form of fiscal drag, capital gains tax, medical tax credits, estate duties and other small increases.
“This means we are starting at a much higher budget deficit next year,” he says.
The tax burden in South Africa is about 26% of GDP, driven in part by economic recovery and also tax increases.
Treasury forecasts an upward trend, although PwC believes this percentage growth has stalled.
Business tax will likely see no increases in tax: the corporate income tax rate of 28% id already high by global standards, Mandy says. There are also no increases expected in corporate capital gains tax or in dividends tax.
“What we do expect is that treasure will continue to close loopholes.”
There has been growing concern about the burden on the individual tax base. “This is now at a record level,” Mandy points out. “More importantly is that tax base has been significantly narrowed, with more of the tax burden now borne by high income earners.”
Although there probably won’t be any tax increases on individual, fiscal drag will likely be felt at high income levels. Medical tax credits will be increased at less than inflation, there is a possible increase of the capital gains tax inclusion rate to 50% and potential for an estate duty increase.
In terms of indirect taxes, PwC doesn’t expect a VAT increase, and an extension of zero-rating to additional items.
There could well be an inflationary increase in the general fuel levy form 15c per lite to 20c per liter, and a substantial increase in the Road Accident Fund levy to 30c per liter.
Mandy believes we will see an expansion of the list of goods subject to ad valorem duties, as an alternative to further taxing luxury goods; and inflationary increase in sugar tax, and an inflationary increase in excise duties on alcohol.
However, PwC doesn’t expect that we will see an increase in excise duties on tobacco, and Treasury may pull the trigger on securities transfer tax.
Carbon tax is expected to be introduced, effective 2019, although it won’t have an impact on tax revenues for 2020.