It’s high noon and South Africa is facing off with the ratings agencies.
This is the word from PwC Strategy& economists Lullu Krugel & Christie Viljoen, unpacking Finance Minister Tito Mboweni’s national budget, presented yesterday.
Key points
* Finance Minister Tito Mboweni delivered his Budget Speech 2020 to Parliament on February 26.
* National Treasury now expects real GDP growth of only 0,9% this year and 1,3% in 2020, compared to forecasts of 1,2% and 1,6%, respectively, announced in October 2019.
* A downside scenario with mounting distress at state-owned enterprises (SOEs) could result in a recession in 2020.
* Suggestions for growth-boosting reforms include resolving the electricity issue and changes to benefit small business, amongst others.
* Fiscal revenues will be R63,3-billion less in 2019/2020 compared to the forecast of February 2019.
* Apart from the usual adjustments to fuel and sin taxes, National Treasury is looking at increased efficiencies as the South African Revenue Service (SARS) to boost revenue in the medium term.
* No changes were announced to tax rates despite widespread expectation of an increase in value-added tax (VAT).
* The government to discuss with labour unions what options are available to reduce staff costs and move the public sector wage bill towards a more sustainable trajectory.
* National Treasury is planning for R160-billion in staff savings over the medium term, thought this still needs to be negotiated with labour unions.
* Consolidated government spending will grow by an average of 5,1% over the medium term largely as a result of fast-rising debt service costs.
* There is no immediate detail on funding for the state bank and sovereign wealth fund.
* Fiscal budget deficit will widen to 6,8% of GDP in 2020/2021 – the largest shortfall since 1992.
* Public debt will breach 70% of GDP.
* The risk of South Africa losing its investment-grade credit rating has become more pronounced.
* While Moody’s Investors Service will find some good news in the Budget Review 2020, most of the key ratings-related elements remain very negative.
* Action is needed to right the fiscal ship – and don’t count on a bailout.
Weak economic growth scenarios, as expected
Budget statements have in recent years perennially made downward revisions in economic growth projections. Disappointing growth outcomes compared to official forecasts is partly attributed to the inability to implement planned structural reforms that would have delivered improved growth outcomes.
As such, it was unsurprising that the Budget Review 2020 again cut growth projections. The National Treasury now expects real GDP growth of only 0,9% this year and 1,3% in 2020, compared to forecasts of 1,2% and 1,6%, respectively, indicated in the Medium-Term Budget Policy Statement (MTBPS) presented less than four months ago and lower than the 1,2% for 2020 projected by the SARB in January of this year. Electricity loadshedding was provided as a key reason for the disappointing growth environment.
As always, the National Treasury provided its views on what is needed to improve the state of the local economy. This includes resolving the electricity issue, increasing access to rail and broadband spectrum, reforms to benefit small business, modernising the foreign exchange control system to attract more investment, and improving the composition of fiscal spending.
The National Treasury considered what the impact would be of opposing forces – stressed State-Owned Enterprises (SOEs) and planned structural reforms – on the economic growth outlook. Under a scenario where reforms are implemented at a moderate pace, economic growth would move closer to the 2% level in 2021 compared to the currently projected 1,6%.
Slow implementation of reforms was highlighted as a serious risk to the growth outlook. A scenario where mounting distress at SOEs further erode the fiscal position, and global growth falters due to trade disruption, a recession could materialise in 2020.
The global outlook is clouded by the adverse effect on trade of US-China tensions, the impact on supply chains of the COVID-19 situation, and a weakened outlook for economic growth in South Africa’s largest trading partners.
Revenues disappoint – but luckily no VAT hike
There is a strong relationship between (nominal) economic growth and fiscal revenues. As such, the weaker economic outlook translates into a deteriorated income outlook for the state. PwC expected revenues in the 2019/2020 to be as much as R65-billion lower than planned in February 2019. The National Treasury reported this figure at R63,3-billion – a number exceeding the under-collection in 2009/2010, in the wake of the global financial crisis.
Slow nominal income growth and a rising unemployment rate have adversely affected personal income tax receipts. Growth in value-added tax has slowed since the one percentage point increase in the VAT rate in 2018 while VAT refunds have also been higher than expected. Corporate tax collections – historically a volatile component of state income – is expected to underperform significantly in 2019/2020.
Local fuel prices will increase by 25c/litre from April this year to adjust for inflation. The plastic bag levy will almost double from 12c to 25c from April. As always, taxes on tobacco products and alcoholic beverages will increase – many by more than inflation, as is the norm. Heated tobacco products and e-cigarettes will also be taxed from 2021.
To boost tax revenues over the medium term, the National Treasury is pinning its hopes on a revitalised South African Revenue Service (SARS). The government is looking at re-establishing integrity and compliance function, restoring public trust and employees’ confidence in the entity, creating a new office focussed on HNWIs, and getting support from the re-established Davis Tax Committee to reduce tax leakages, customs fraud and trade mispricing. SARS is also reviewing its procurement processes.
On another positive note, no changes to current tax rates are envisaged over the medium term. In light of a warning on October 2019 that increases in tax rates could be used the address the fiscal (im)balance, many analysts warned that an increase in the value-added tax (VAT) rate was on the cards for the 2020/2021 fiscal year. Nonetheless, despite wide expectation of higher tax rates, the finance minister announced no tax increases in the interest of supporting economic growth.
Furthermore, the National Treasury is implementing above-inflation relief on personal income taxes. Tax brackets and rebates will be increased by 5,2% compared to forecast inflation of 4,4%. Someone earning R265 000 per annum will see their income tax reduced by over R1 500 a year. Lower income earners will receive the bulk of this progressive benefit: someone earning R10 000 a month will pay 10% less tax while someone earning R100 000 a month will pay about 1,5% less.
Plans for some saving on the public sector wage bill
Less money to spend means making changes to expenditure. Spending has moved away from capital investment towards consumption spending over time. One key challenge on the consumption side is the public sector wage bill. The National Treasury reported that real (i.e. inflation-adjusted) public sector salaries have increased by 40% over the past 12 years “without equivalent increases in productivity”. The remuneration growth has been “increasingly out of line with the rest of the economy”.
The government – who is currently locked into a three-year wage agreement with its workers – plans to discuss with labour unions what options are available to reduce staff costs and move the public sector wage bill towards a more sustainable trajectory. Options include changes in cost-of-living allowances, pay progression and other benefits. The Budget Review 2020 did not refer to the possibility of reducing staff numbers.The finance minister instead indicated a need to increase staff in important areas like education, police and healthcare.
If the proposed wage reductions can be implemented, real consolidated compensation spending could decline by one percentage point an average of over the medium term. National and provincial governments are proposed to receive R37,8-billion less for the compensation budget in 2020/2021 and a total of R160-billion over the three-year budget period. If this materialises, it will support in limiting expenditure growth. The details still need to be negotiated with labour unions, so the entire R160-million will probably not be secured.
Total consolidated government spending will grow by an average of 5,1% over the medium term largely as a result of fast-rising debt service costs. This growth rate takes into account R261-billion in programme and wage bill spending reductions. At the same time, R111-billion in additional allocations have been made, including R60-billion towards the financial needs of Eskom and South African airways.
There is no immediate detail on how a proposed state bank and sovereign wealth fund will be financed. President Cyril Ramaphosa indicated recently that the finance minister would give more information on these two entities in his speech. The state bank was billed as a state-owned financial institution that will be operated as a commercial bank. The sovereign wealth fund could be financed by a variety of possible funding sources, with more to be announced in the MTBPS 2020.
Little impact on budget balance from MTBPS warnings
The MTBPS 2019 set out plans for the central government to achieve a main budget primary balance – ie: revenue equal to non-interest expenditure – by 2022/23. Given the above, the National Treasury had to admit that this aim is now out of reach. The departure point for their goal is turning out to be a bad starting point, with the fiscal deficit set to widen to 6,3% of GDP – in line with PwC expectations – in the current financial year.
Taking into account the above information in income and expenditure, the National Treasury estimates that the fiscal budget deficit will widen to 6,8% of GDP in 2020/2021. This is a massive departure from a figure of 4,3% presented a year ago. The proposed fiscal deficit will be the largest since 1992. The reality of this situation is that the dire MTBPS 2019 – aimed at scaring key people into realising how desperately the country needs to make changes to the economy and fiscal scenario – has largely fallen on deaf ears.
Budget Review 2020 also listed some risks to this already bleak outlook. These include insufficient progress in righting the ship at Eskom, an underwhelming outcome with the renegotiation of public sector remuneration, and a lack of clarity on a solution to the fiscus-draining e-tolls. Progress on all three of these points have been slower than required to reduce their impact on the fiscal situation.
Public debt heading only one way: up
It is important to note that the pro-consumer fiscal stance – not increasing VAT and above-inflation PIT relief – is a short-term boost to the economy with long-term implications. Easing the household tax burden today requires increased government borrowing tomorrow, and a higher debt burden for taxpayers to carry in the future. By not further cutting spending (over and above the ones discussed above) and/or lifting tax rates, the National Treasury has kept the budget deficit very wide.
Current deficit projections are not significantly different form those presented in the MTBPS 2019. As such, the public debt trajectory is also not much different from that envisioned some four months ago. Nonetheless, the outlook is much worse than it was a year ago, and public debt is rising to above 70% of GDP. This is already notably higher than a level of 60% of GDP which the International Monetary Fund (IMF) has in the past referred to as “uncomfortable”.
High noon: ratings and bailouts
The Budget Review 2020 acknowledges that “[t]he risk to South Africa’s remaining investment-grade credit ratings has become more pronounced. Indeed, the road ahead for the country’s sovereign ratings is all but rosy.” Moody’s Investors Service – the only rating agency still providing South Africa with an investment-grade rating – already has the country on a negative outlook.
Was there good news for rating agencies in Budget Speech 2020? Yes, but not a lot. Efforts to address the public sector wage bill will be a positive, if it is indeed implemented. So too all the intentions for reforms going forward – this has been an important downgrade buffer for Moody’s for some time. However, the realities are that economic growth forecasts have been revised lower, expenditure has not been trimmed significantly, and the budget deficit is ballooning. As a result, public debt is rising rapidly, with little prospect of the trajectory looking any better come MTBPS 2020.
Moody’s is scheduled to publish its next ratings review of South Africa during March 2020. There is a widely held view amongst economists that the agency will downgrade South Africa this year, with some suggesting that it could happen next month already. Irrespective of the exact timing, the loss of South Africa’s last investment-grade rating is quite certain to happen. Something needs to be done, and very quickly, to avoid this. It is High Noon at the Last Chance Saloon.
But don’t count on a bailout. Every few months, local media reports on comments and speculation about an IMF bailout for South Africa to cope with its fiscal, debt and ratings malaise. Sovereign states like South Africa are able to approach the IMF for financial and technical (non-financial) support during both calm and stormy conditions. In troubled times, the IMF can consider a bailout, or what the multilateral organisation calls “crisis lending”.
It is important to note that South Africa is not in crisis lending territory. The country is not experiencing any of the major risks that would let it quality: a natural disaster, large swings in commodity prices, capital-flow volatility, or a balance of payments crisis. Furthermore, crisis lending is only provided upon request and South Africa has not asked for a bailout. Even if the country does make such a request, a bailout is not a cash gift, it is a loan and increases public debt.
• Lullu Krugel is chief economist and partner at Strategy&; and Christie Viljoen is economist and manager at Strategy&