When Finance Minister Tito Mboweni presented his Medium-Term Budget Policy Statement yesterday, he laid out a morbid outlook for the fiscus in the absence of reforms that are now envisaged for announcement in the Budget Speech 2020.
Lullu Krugel and Christie Viljoen, PwC Strategy& economists, unpack the news.
The MTBPS communicates to government and the people the economic context of the country and fiscal spending priorities over the coming three years. It does not include detailed spending plans or tax proposals, which are left to the main budget in February.
Minister Mboweni indicated that the MTBPS sets out plans to boost economic growth, reduce government expenditure, and improve the quality of fiscal spending.
However, the latest version of the document reflects a significant deterioration in many fiscal projections.
Admittedly, there are promises of hope for improved numbers in the Budget Speech 2020.
Key points:
* Economic growth projections revised lower (o.5% in 2019, 1.2% in 2020) in the absence of progress on structural reforms;
* Progress in launching the Infrastructure Fund and identifying projects for public private partnerships;
* R128-billion in provisional support for Eskom, but debt relief not considered until operational changes and progress s visible;
* Current financial year is expected to see R460billion less in revenue than planned in February due to weak growth in all tax categories;
* Expenditure plans revised higher to accommodate additional financing to financially troubled state-owned enterprises (SOEs);
* A planned 2% reduction in goods, services and infrastructure spending over the medium-term is good news, but below the 5%+ level asked from government departments;
* Fiscal deficit expected to balloon from 4.0% of GDP in 2017/18 to 6.5% of GDP in the 2020/21;
* National Treasury looking at reduced growth in the public sector wage bill, further tax increases and a sustainable plan for SOE funding to narrow the deficit;
* If the finance minister can push through reforms by February 2020, medium-term fiscal projections could look somewhat better from those released here;
* Government gross loan debt increasing from 56.7% of GDP in 2018/19 to 71.3% of GDP by 2022/23, in the absence of policy adjustments;
* Moody’s Investors Service will comment on the South African sovereign’s creditworthiness on November 1 – the MTBPS will certainly push debt metrics beyond critical (downgrade) levels; and
* On a positive note, the government has a prudent debt management process in place and its debt portfolio mix remains well managed by international benchmarks.
Minister Mboweni echoed frequent calls for the South African Reserve Bank (SARB) for structural reforms in order to reignite economic growth. This will come from the National Treasury’s economic policy paper that was released in its second iteration alongside the MTBPS. For now, the National Treasury expects economic growth of only 0.5% this year. A figure of 1.2% for 2020 will be less than population growth for the sixth straight year.
Outer year projections are now below 2.0% due to deteriorating long-term growth potential, productivity and competitiveness.
Of course, the minister wanted to create some optimism about government efforts underway to increase potential economic growth. He referred to the National Treasury’s original economic policy paper – released in August 2019 – as containing many of the ideas presented a year ago in the MTBPS 2018 for boosting growth. (Implementation is slow given that the paper has now first “begun a vigorous public debate on the reforms required to raise growth.”)
On the infrastructure front, he provided an update on the country’s blended-finance Infrastructure Fund. The fund’s implementation unit has been established and is house at the Development Bank of Southern Africa (DBSA) and has begun identifying policy and regulatory hurdles to increasing public-private partnerships in the infrastructure space.
The National Treasury will allocate R10-billon per annum over the next three years for co-funded projects with the private sector. There are R500-billion worth of identified projects that could benefit from this.
The MTBPS provides a long list of well-known factors suppressing economic growth over the past five years and emphasises that reversing the current low-growth trajectory requires urgent action.
Under a heading “economic reforms to implement without delay”, the MTBPS again refers to August’s economic policy paper as offering many plans to undo growth constraints. The finance minister also listed immediate action points, including reducing the cost of flying to South Africa, granting of licenses to small-scale power generation projects, and developing a single platform for registering a business.
Eskom
The MTBPS reiterated that Eskom is the country’s biggest economic risk. The MTBPS pledged that government will step up its efforts to address the power utility’s operational and financial challenges.
Some R128-billion in provisional support has been set aside for the 2019/20 – 2021/22 period, and should Eskom be unable to issue debt, this number could increase. On the debt front, the National Treasury indicated that additional efforts to address the power utility’s debt burden will only be considered once Eskom has made cost reductions and progress towards unbundling.
The government currently envisages a two-step timetable for Eskom’s restructuring. Phase 1 will be to functionally separate the entity into three functions (generation, transmission a distribution) with their own boards by March 2020 – a tight deadline. Phase 2 will be to complete the legal separation of the three entities by December 2021.
Neither of these processes currently include any debt relief for Eskom. However, the National Treasury has laid out a list of requirements for Eskom’s board in order to consider debt relief, including measurable progress in cash management, creating the three separate functions, and appoint effective leadership structures for each with the requisite skills. “Eskom is a business and should be run that way,” said the minister.
Debt relief is expected to happen over time as progress is made in these areas.
Revenue falls far short of expenditure demands
Explanations were given in the MTBPS for weak tax revenues: rising unemployment pressuring personal income tax, reduced corporate profitability weighing on corporate tax, inefficiencies as at the South African Revenue Service (SARS) and weak household consumption reducing value-added tax (VAT) collections. Forecast fiscal revenue was revised lower over the medium term.
The current financial year is expected to see R46-billion less in revenue than planned in February – an under-recovery of 2.9%. Large reductions were also made for the following years due to the lagged effect expected of planned reforms on economic growth.
On the expenditure side, the National Treasury admitted that government spending – and associated large fiscal deficits – have not translated into stronger economic growth. Failure to implement structural reforms – despite many of these being identifies in the National Development Plan (NDP), published in 2011 – and the deteriorating composition and quality of fiscal spending resulted in the potential boost from fiscal support failing to materialise.
However, this will not lead to a rollback of spending. Fiscal expenditure plans are revised higher in this MTBPS, largely to accommodate additional financing allocated to financially troubled Eskom. In total, spending will rise by R55,8-billion over the 2019/20 – 2021/22 period compared to the numbers published in February.
At the same time, Minister Mboweni indicated that authorities are putting in place plans to address this planned increase. Solutions will be found in the economic policy paper, thought the public sector wage bill also needs serious attention before any significant impact will be seen.
Addressing the public sector wage bill is a thorny issue. The MTBPS acknowledges the challenge in reducing the wage bill which currently accounts for about 35% of consolidated budget spending. (The average civil servant wage increased by a real 66% over the past decade.)
The government first needs to discuss staff costs with the labour unions – a key element within the ruling tripartite alliance. It has already struggled to convince workers qualifying for early retirement to take this option: results have been underwhelming, with only 3 500 applications. As such, no tangible progress was announced on staff cost reductions in the MTBPS with progress only expected to be reports in the Budget Speech 2020.
Some small steps at the highest level of government were also announced to curb spending – these will save some money, but nothing near the magnitude required to right the fiscal ship.
The MTBPS indicated that President Cyril Ramaphosa has approved a remuneration freeze (and possible salary cuts) for Cabinet ministers, the capping of official cars’ costs at R700 000, a new cellphone dispensation for officials, and domestic air travel limited to economy class only.
An important point to note on the spending reduction front is that, with Eskom being the biggest factor in rising expenditure, baseline expenditure plans have actually been reduced.
Put differently, the general spending on goods, services and transfers are planned to decline. This is visible in a planned R8,2-billion reduction in non-interest spending in the 2020/22 fiscal year. And from the 2022/23 period onwards, National Treasury aims to link spending increases to the inflation rate.
This is, at least, some good news on the spending front. It is however less positive than could have been: a planned 2% reduction in goods, services and infrastructure spending over the medium-term is below the 5%+ level that Minister Mboweni recently asked government departments to make in their planning.
The fiscal deficit and stabilising public finances
In February, the National Treasury indicated that the fiscal deficit was forecast to widen from 4.0% of GDP in 2017/18 to 4.5% of GDP in the current (2019/20) financial year.
Considering deteriorating revenues growth, increased spending obligations, and no guarantee that proposed expenditure reform measures will have a significant impact on the state purse, the deficit is now forecast to balloon to 6.5% of GDP in the 2020/21 period.
The only way to address this fiscal plunge is to roll back expenditure. Specifically, the MTBPS is aiming to see a main budget primary balance – so revenue equal to non-interest expenditure – by 2022/23.
The National Treasury sees three (very challenging) ways to achieve this:
* Reduced growth in the public sector wage bill to the benefit of spending on other important cost points;
* Further tax increases (with “moderate scope” for boosting revenues in this way); orand
* A sustainable plan for the funding of SOEs.
These endeavours, it has been promised, will be released with the Budget Speech 2020 in February next year. The minister warned that decisions in this regard will be tough, but that the short-term costs will be outweighed by the need for sustainable long-term public finances.
If he can push through these reforms by February 2020, the medium-term fiscal projections could look somewhat better from those released this month.
In a bid to improve spending efficiency and reduce wasteful expenditure, the National Treasury will over the coming year:
* Merge and consolidate regulatory entities and agencies;
* Implement recommendations from expenditure reviews;
* Dispose of unused land and other assets;
* Reform the ministerial handbook in order to manage the benefits of office bearers; and
* Review the existing procurement framework to simplify procurement processes.
Rising public debt, increasing pressure on rating agencies
The MTBPS is frank in saying that debt repayment obligations are crowding out economic and social spending programmes and that this cannot be sustained. However, for the time being, many of the ideas that the MTBPS has put on the table still needs to be implemented. This implies delays in shoring up revenues and reducing expenditure growth.
As such, and pending success in these areas, the fiscal deficit will remain huge, and debt accumulation a reality. The National Treasury is now planning for government gross loan debt to increase from R2.79 trillion (56.7% of GDP) in 2018/19 to R4.48 trillion (71.3% of GDP) by 2022/23, in the absence of policy adjustments. This will be a massive increase in pure rand terms as well as the GDP ratio. (In February, the debt outlook was flirting with the 60% of GDP mark, and is now set to break the 70% of GDP level in a few years’ time.)
The MTBPS admits that since the Budget Speech 2019, risks of further sovereign ratings downgrades have increased due to low economic growth and rising public debt. The latter is a crucial issue. Moody’s Investors Service – the only ratings agency still to rate South Africa at investment grade – already has a bloated view of the country’s public debt after recently adding Eskom’s government-guaranteed debt obligations to those of the sovereign.
The MTPBS’s downward revision on economic growth and upward revision in planned state lending will certainly push Moody’s debt metrics beyond critical levels, leading to a downgrade to non-investment grade if the agency wants to maintain its integrity. (Moody’s is scheduled to comment on South Africa’s creditworthiness on November 1.)
The only immediate lifebuoy would be if the agency latches on to the multiple promises of change to be revealed in February 2020.
On a positive note, the government has a prudent debt management process in place. The National Treasury uses international benchmarks for structuring its debt portfolio and remains within these limits. Interest, inflation, currency and refinancing risks are under control on accumulated debt. For example long-term, fixed rate bonds are the mainstay issuance for South Africa’s borrowing needs, which protects public finances from sudden interest and exchange rate shocks. Furthermore, the majority of borrowing is done in local capital markets.
Final thoughts on the fiscal game plan
The MTBPS 2019 was Minister Mboweni’s best kick into touch under the circumstances. In team ball sports like rugby and soccer, kicking into touch can take a lot of pressure off a team. It delays the immediate threat of a pressured encounter and relieves pressure on the players.
However, while relief can help in staging a better offensive manoeuvre, kicking into touch can also backfire in that the opposing team counters with their own tactics. Minister Mboweni has many opponents in trying to realise the processes made for Budget Speech 2020.
Rating agencies – some might call them the referees in this game – are likely to be unpleased with the MTBPS kick, thereby building the pressure on the National Treasury heading down the road to February 2020.