The Minister of Finance, Nhlanhla Nene, presented his second Medium Term Budget Policy Statement (MTBPS) today under fairly difficult macro-economic and political circumstances. (The EFF argued strongly that the MTBPS should be postponed as a result of the current crisis in higher-education).
The government’s GDP growth forecast has been revised down sharply from an initial estimate of 2.0% for 2015, 2.4% for 2016 and 3.0% for 2017, at the time of the February 2015 National Budget, to 1.5% for 2015, 1.7% for 2016, 2.6% for 2017, and 2.8% for 2018. The downward revisions reflect a combination of factors including weaker than expected world growth, increased labour market unrest in South Africa, regular electricity outages and weakening business and consumer confidence.
Unsurprisingly, tax revenue has underperformed budget somewhat in the past six months, given the downward revisions to GDP growth. Consequently, total government revenue for the 2015/2016 tax year has been revised down by R7.6bn in 2015/16, R14.6bn in 2016/17 and R12.4bn in 2017/18 compared with the projections tabled in the 2015 Budget. In total lower growth has resulted in a downward revision of R35 billion to tax revenue between 2015/16 and 2017/18.
It is clear that projected revenues from corporate income tax and value-added tax (VAT) have underperformed for the first half of the current fiscal year, and have, consequently, been revised downward. National Treasury estimates that the budget shortfall in corporate revenue for 2015/16 will amount to R13.0 billion, while the VAT shortfall is estimated at R3.3 billion. In contrast, personal income tax (PIT) collection has been stronger than expected (with an estimated revenue over-run of R2.1 billion), supported by above-inflation wage settlements and higher marginal tax rates. (See chart attached).
It appears that the under-collection of corporate income tax in the current tax year is mainly due to contractions in the mining and manufacturing sectors on the back of poor global demand, lower commodity prices and domestic electricity constraints.
Non-tax revenue in 2015/16 is expected to be R28.9 billion higher than the 2015 Budget estimate. This is attributed to the R25.4 billion sale of Vodacom shares and higher receipts from other financial transactions.
The Minister indicated that taxes are likely to increase in the February 2016 National Budget, including, including the introduction of a carbon tax. The detailed proposals for these tax increases will be outlined in next year’s budget, but presumably they will flow from the recommendations of the Davis Tax Committee.
Since 2014 the Davis Tax Committee has published reports on small business taxation, value-added tax (VAT), base erosion and profit shifting, estate duty and mining taxation. The committee also published a report on the role of the tax system in supporting inclusive growth, employment, equity and fiscal sustainability.
In terms of a possible increase in VAT, the National Treasury highlighted that while VAT might be perceived as regressive, comparative studies show that South Africa’s overall fiscal system (tax and public expenditure) is strongly redistributive. To date, no decision has been made about a possible hike in VAT, but an increase remains one of the options available over the medium term to finance key elements of the National Development Plan.
Government’s estimate of expenditure for the 2015/16 fiscal year has been increased by a very substantial R27.7bn relative to the February 2015 National Budget. This partly reflects the increased spending on salaries by government, but also the impact of other expenditure over-runs as well as the weaker exchange rate. For example the most recent public-sector wage agreement led to a compensation budget shortfall of R12.2 billion in the current fiscal year, R20.6 billion in 2016/17 and R31.1 billion in 2017/18.
Government’s latest settlement with public sector unions increases the salaries and benefits of public servants by 10.1 per cent in the current year, followed by improvements that will be at least two percentage points higher than consumer inflation in the next two years.
The contingency reserves have been sharply reduced to accommodate the increase in government salaries, and to fund critical social priorities. In particular, the R5 billion contingency reserve for 2015/16 was fully absorbed by the wage bill shortfall. Projected reserves of R15 billion and R45 billion in the two subsequent years have been cut to R2.5 billion and R9 billion respectively.
This is far from ideal and leaves the country vulnerable. In addition the Minister indicated that the revised MTEF provides no funds to expand public-sector employment over the next three years. Departments that had planned to expand headcount or fill vacancies will need to postpone their plans. In addition, some institutions may need to reduce the number of people they employ.
In terms of nuclear energy, the National Treasury said it is working with the Department of Energy to consider the costs, benefits and risks of building additional nuclear power stations. Over the medium term, R200 million will be allocated to support preparatory work for nuclear procurement.
Elsewhere, there remains a focus on trying to improve the efficiency of government spending and the reduction in wasteful expenditure. While some of savings sound impressive in percentage terms they remain small within the context of the National Budget. This is reflected in the magnitude of the overall increase in budgeted expenditure for 2015/16.
Deficit and debt
The combination of lower tax revenue, and increased government expenditure means South Africa’s projected budget deficit for the next 3-years has been revised higher. Although the fiscal deficit for 2015/2016 has been revised slightly lower from -3.9% of GDP to -3.8% of GDP (helped enormously by the sale of government’s stake in Vodacom), it is then projected at -3.3% of GDP in 2016/17, -3.2% of GDP in 2017/18, and -3.0% of GDP in 2018/19. This is above the February 2015 Budget projection for the deficit to fall well below 3% of GDP by the end of the 2016/2017 fiscal year.
A key risk to South Africa’s ongoing fiscal stability is the increase in state debt cost. While the interest cost on state debt remains manageable at less than 10% of total expenditure, it is the fastest growing component of government expenditure. In fact, nominal growth in interest and rent on land is expected to average 10.3 per cent over the next three years. Under these circumstances, a significant rise in bond yields, due to the normalisation of global interest rates, would put South Africa’s fiscal position under increasing strain.
The downward revision to GDP, shortfalls in revenue and the weaker exchange rate have also led to an upward revision of the government’s debt-to-GDP ratio. According to National Treasury data, gross debt is projected to rise to a very concerning 49% of GDP in 2016/2017, but then stablise around that level (see chart attached) as a result of continued restraint in expenditure growth and improvements in the budget balance. Under these circumstances, government’s gross debt stock is projected to increase by about R600 billion over the next three years, reaching R2.4 trillion in 2018/19. This excludes government growing level of contingent liabilities as well as debt in the name of public corporations that is not explicitly guaranteed by government.
The MTBPS offered no new initiates, but instead highlighted that without economic growth, tax revenue will not rise, and that without an increase in tax revenue, government will struggle to accomplish its expenditure goals. The impact of weaker economic growth is evident in government’s downward revision to its tax revenue estimates over the next 3 years.
It is also clear that the government’s wage bill has become an enormous constituent of the national budget and is proving difficult to contain. This has systematically eroded government’s ability to embark on a meaningful and sustained increase in infrastructure spending.
The near-term deterioration in South Africa’s fiscal parameters (budget deficit and debt ratios) is not unexpected, and largely in-line with most analyst’s projections. The intention, on the part of the Minister of Finance, to maintain fiscal discipline is applauded and evident through-out the MTBPS and accompanying speech, but this is likely to become increasingly more difficult to achieve given the wide range of social demands – including the cost of education, energy, water, and numerous other services that remain in short-supply. The credit rating agencies will be paying close attention to latest set-back in government fiscal parameters, rising social tension that threatens to spill-over into widespread social unrest, and that lack of progress in inspiring private sector investment and job creation.
Clearly, the increase in government debt remains a significant concern given that South Africa’s international credit rating has already been revised lower. (In June 2014, Standard and Poor’s downgraded South Africa’s long-term foreign currency credit rating to BBB- from BBB, but with a stable outlook. Unfortunately, there is a high probability that the Fitch Rating Agency will also downgrade South Africa’s credit rating from BBB to BBB- at the next review in December 2015 given that they already have South Africa on a negative credit watch). Consequently, it is critical that government’s expenditure ceiling is not breached, the public sector wage increase in contained and that a concerted effort is made to raise South Africa’s growth rate through the encouragement of private sector business.
A half hour ahead of the MTBPS, South Africa’s R186 government bond was trading at a yield of around 8.308% and the R/$ exchange rate was about R13.42. A few hours after the release of the MTBPS the R186 had weakened a little to 8.38%, and the R/$ exchange rate had depreciated R13.51/$. Over the same timeframe the Top 40 share index rose fractionally from 53 189 to 53 215.
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