The government continues to focus on restoring fiscal discipline while shifting a greater proportion of its budget into infrastructure development. This remains a slow and arduous process.
On Wednesday 27 February 2013, the Minister of Finance, Pravin Gordhan, presented his fourth National Budget since taking office in 2009. Once again the Minister tried to balance a range of competing objectives, under difficult economic conditions. The Minister had less room to manoeuvre this year compared with prior years given the revenue shortfall as well as the recent decision by the credit rating agencies to downgrade the country.
The international credit rating agencies will evaluate the credibility of the Minister’s intention to restore fiscal discipline over the next three years. While Fitch has moved South Africa’s rating outlook from negative to stable, following its long-term foreign currency rating downgrade for South Africa in January, Moody’s and S&P have maintained their negative outlooks on the sovereign.
The business community will appraise the Minister’s plan to encourage much-needed infrastructural development and job creation, while the household sector will assess the impact of the tax changes on their personal finances.
While the Minister has, once again, achieved a reasonable balance, the budget tends to lack an over-riding and inspiring focus, partly constrained by a lack of growth in the tax base.
A transparent budget
South Africa recently slipped into second position in the 2012 Global Open Budget Index (which measures the transparency of each country’s national budgeting process), after being ranked first in the 2010 survey, nevertheless this remains a remarkable achievement.
Unfortunately, a transparent and efficient budgeting process is a necessary but not sufficient condition for effective government. Once National Treasury has allocated the funds and set the key expenditure priorities it is up to each government department to deliver an acceptable outcome using the funds available. That is clearly not happening, especially in key areas such as education and healthcare.
The economic outlook
During 2012, global growth remained relatively subdued, with a below-average performance in the mature economies being partially offset by somewhat higher growth in emerging economies. The United States continued to recover at a moderate pace, although the Euro-area fell back into recession and Japan was dragged lower by a weak export performance and increased political tension with China. Encouragingly, the outlook for the global economy in 2013 is more promising given the somewhat enhanced financial stability in the Euro-area, improved economic data in China and a pick-up in United States housing activity. Sub-Saharan Africa, once again, outperformed most other regions of the world, growing by a solid 4.8% in 2012, having achieved an average growth rate of 5.5% over the past ten years.
South Africa has experienced 14 consecutive quarters of positive growth, following the recession in 2008/2009. Unfortunately the rate of growth slowed to only 2.5% in 2012, after recording growth of 3.5% in 2011 and 3.1% in 2010.
Retail activity played a dominant role during the recent economic recovery. This is mostly explained by relatively high wage increases of above 8% for the past few years, as well as an increase in government employment. The combination led to a strong rise in real household disposable income. Unfortunately, because most South African households do not have a culture of savings, almost all the rise in disposable income was spent on a range of consumer goods and services. More recently, there has also been a surge in unsecured credit, which has also helped to buoy retail spending in 2012.
On a trend basis, however, there is clear evidence to suggest that South Africa’s consumer activity is facing increasing strain. This is partly due to the fact that consumers are trying to cope with a range of cost increases that are systematically eroding their spending power. These include higher energy costs, transport costs, education fees, medical service costs and water costs. Households cannot avoid these increases, as they relate to necessities or essential goods, forcing consumers to either cut-back on non-essential purchases or take on additional debt. Hence, without a sustained rise in employment, consumer activity is expected to lose momentum.
The South African corporate sector has managed to systematically improve their financial position, despite an uncertain market environment. This is reflected in solid earnings growth, an elevated cash position, and low gearing. Unfortunately, the corporate sector’s willingness to expand and employ has been dampened by a combination of poor global economic conditions (especially in the Euro-area), domestic policy uncertainty, disruptions to the local power-supply, a lack of transport infrastructure (including rail and port capacity), as well as a rise in labour market unrest. It is time for SA macro-economic policy to find a way to encourage the SA corporate sector (partly through the development of appropriate infrastructure) to become more expansionary as well as entrepreneurial in order to lift SA growth rate.
National Treasury, once again, revised down their growth forecast for 2013 to 2.7% from the 3.0% they published in the October 2012 Medium Term Budget Policy Statement (MTBPS). In addition, the growth outlook for 2014 has also been reduced to 3.5% from 3.8% in October 2012 and 3.8% in 2015, down from 4.1% in October 2011. The downward revision to the growth outlook partly reflects the troubled global economic environment, a still weak export performance, as well as some moderation in consumer activity.
More positively, the National Treasury revised up their forecast of fixed investment spending in 2013 to 5.7% from 4.5% in October 2012. Investment spending is then expected to grow by 5.9% in 2014 and 6.5% in 2015. The improved outlook for investment activity is partly driven by the impending and dramatic rise in Transnet’s capital expenditure programme, as well as a general uplift in infrastructural development.
The budget numbers
For the 2012/13 fiscal year the Minister of Finance expects the budget balance to record a deficit of 5.2% of GDP. This is worse than the 4.8% the Minister projected in the October 2012 MTBPS, largely as a result of the deterioration in tax revenue. Tax revenue is currently projected to under-shoot the February 2012 budget by around R16.3 billion (R11 billion due to the under-collection of corporate taxes). Government expenditure grew by an estimated 10.7%y/y in 2012/13 fiscal year, unfortunately this included under-spending on infrastructural projects. Looking further-out, the Minister is projecting that the budget deficit will fall to 4.6% of GDP by 2014/2015 and to a mere 3.1% of GDP by 2015/16, with the public sector wage bill rising by an average annual rate of around 6.9%. While these objectives are laudable, the targets will be difficult to achieve without a significant rise in economic growth as well as tax revenue.
The revenue side of the budget
Total government revenue is budgeted to increase by a relatively substantial 11%y/y in fiscal 2013/2014, which seems high compared with growth of only 6.1% in 2012/13; and is likely to prove difficult to achieve given the modest GDP growth forecast. The composition of tax revenue is not expected to change significantly over the coming year, with the bulk of the revenue still being derived from direct taxes in the form of personal income tax (35.1% of total) and company tax (19.5% of total).
Indirect taxes, such as VAT and the fuel levy, have grown steadily over the years and now comprise an indispensable component of tax revenue. In fact, the revenue received from VAT (27.8% of total) consistently and significantly exceeds corporate tax receipts, with 2013/2014 not expected to be any exception.
The Minister announced very few tax changes in the budget, in-line with general expectations. The largest tax change
was an adjustment to the thresholds and tax brackets applicable to individual income tax. This is really to alleviate some of the effects of inflation, or what is referred to as ‘fiscal drag’. The value of this adjustment is around R7.0 billion, which is not really enough to compensate for the effects of inflation or fiscal drag; and is below the R9.5 billion tax relief that was granted to individuals in last year’s budget.
The Minister left the top marginal personal tax rate of 40% unchanged, although the threshold at which this is reached was increased modestly from R617 001 to R638 601 (a rise of a mere 3.5% which is well below inflation). The change in threshold/brackets means that someone earning R100 000 a year will get an annual tax relief of R640, while someone earning R1 000 000 will get tax relief of R3 015, well below the R4 795 tax relief received last year.
Other tax changes include a shock 22.5c/l increase in the fuel levy (7.5c/l of this is to pay for additional pipeline capacity) as well as an 8c/l increase in the fuel price for the road accident fund. The increase in the fuel levy is expected to raise an additional R3.3 billion in revenue. Unfortunately, South Africa is currently also experiencing a significant daily under recovery on the domestic petrol price of around 80c/l. This means that over the next two months (fuel levy increase comes into effect in April) the local petrol price could rise by a further, and confidence sapping, 110c/l, taking the price of 95 Octane in Johannesburg to a record high of R13.37c/l. This will negatively impact inflation as well as consumer activity.
The Minister also announced the customary increase in excise duties (including taxes on alcohol and tobacco), which is projected to provide the government with an additional R2.1 billion in revenue.
Importantly, the Minister announced that government will undertake a comprehensive review of tax policy. This review will be chaired by Judge Dennis Davies, and is scheduled to start this year. It will include an assessment of mining taxes.
Overall, although the Minister provided some tax relief to individuals in order to compensate for the effects of fiscal drag, this was mostly offset by the increase in the fuel levy as well as the excise duties. Correspondingly, this was not a consumer friendly budget, which ultimately reflects the need for the Minister to contain the budget deficit.
The expenditure side of the budget
Over the next three years the Minister is projecting average expenditure growth of 8.1% a year. This is relatively moderate, suggesting that government is willing to dampen the growth in spending in order to restore fiscal discipline over the medium term.
Key areas of growth in government spending during 2013/2014 remain education, health, including housing and community development, education, public order and safety. The Minister also announced a continued focus on infrastructural activity, with Transnet at the centre of the strategy. The government is planning to spend a massive R827 billion on infrastructural development over the next three years, although strangely this is almost R20 billion below the level of planned infrastructure spending that was announced last year. Hopefully, we will start to see the long-awaited improvement in infrastructural delivery, but unfortunately most analysts are likely to remain skeptical given the disappointments of the past.
As expected the Minister highlighted the role of the Jobs Fund, which was launched in 2010. The fund has a capital base of R3 billion, with a further R3 billion provided by the private sector, but has achieved moderate success in stimulating job creation. Additional tax measures to encourage youth employment are also expected to be announced reasonably soon. The official unemployment rate in South Africa is still around 25%. This excludes millions of discouraged workers. Importantly, 70% of SA’s unemployed are younger than 35, while the unemployment rate among people aged less than 25 is around 50%. Furthermore, 64% of all unemployed people do not have a matric qualification. Over the past year, the SA economy has added a mere 80 000 jobs, which is well below the key target level of 500 000 a year. Since the low point in 2010, South Africa has gained a total of 602 000 jobs. Total employment remains, however, 450 000 below the peak prior to start of the global financial market crisis in 2008.
As we have discussed on numerous occasions, job creation is not merely a function of the cost of capital or even the cost of labour. A range of important policies play a crucial role in facilitating job creation, including labour regulation, education (skills development), competition policy (regulation of industry), industrial policy, trade policy, and infrastructure development. SA’s high unemployment rate requires a far more complete and bold solution, which has the role of the private sector firmly at its core, supported by appropriate infrastructural development.
South Africa’s unemployment rate remains far too high by historical and international standards, and clearly contributes to much of the social tension and anguish experienced in South Africa on a daily basis. Increasing employed in South Africa has to be the number one economic/political/social objective.
The rise in the budget deficit over the past few years comes at a high cost. Government debt has risen from a low of 27.3% of GDP in 2008/09 to 41.8% of GDP in 2012/13 and is projected to rise to 43.2% of GDP in 2013/2014. This is the largest debt level, as a ratio of GDP that South Africa has experienced since 2000/2001.
The higher the debt, the higher the interest cost associated with that debt. In South Africa’s case, the interest cost of state debt is projected to rise to almost R100 billion in 2013/2014. Over the past three years the cost of state debt has risen by an average annual rate of almost 16%, making the cost of state debt one of the fastest rising expenditure items in the budget.
Fortunately, although the cost of state debt is rising sharply, it remains manageable within the context of the National Budget. For example, the interest cost of government debt is still below 10% of the budget and represents only 2.8% of GDP. As a comparison, many European countries have a public debt to GDP ratio of well over 100% with the interest cost of that debt above 5% of GDP.
While South Africa’s public sector debt parameters remain very acceptable by world standards, the total debt as well as the cost of servicing that debt is clearly on the rise. If left unchecked, government debt will quickly become a major hindrance to achieving many vital policy objectives. Already the cost of debt exceeds the total budget allocation to police services. Hence the Minister’s decision to focus on maintaining fiscal discipline, despite difficult circumstances, has to be applauded.
The Minister’s decision to avoid the temptation of raising taxes is extremely welcome, as this could have undermined the medium term growth objectives.
Overall, while the tone of the budget can be considered appropriate given the competing demands on government’s limited resources; having the right tone or emphasis is simply not enough. The government has consistently highlighted the need for infrastructural development, but has struggled to implement its budgeted objectives. It is crucial that this now gains traction.
The road to restoring fiscal discipline will also not be easy. In particular, the government is likely to struggle to contain dependencies for increased social spending. In addition, the growth in tax revenue will only be achieved if there is a reasonable pick-up in economic growth.
South Africa: National Budget 2013/2014 Presentation