Finance Minister Pravin Gordhan pulled several rabbits out his Budget hat on Wednesday, February 24, when he delivered the first Budget Speech of his current, second term.
However, the rabbit one marked ratings downgrade averted did not emerge, and markets appeared initially unconvinced that government could deliver on Mr Gordhan’s vision.
That judgement may change over the next few days as the details of the Budget are digested but, then again, it might not. The markets’ opinion of Treasury’s plans may even get worse if any disconnect between the political system and the Treasury emerges.
The fact that President Jacob Zuma felt moved to announce his support for the Budget implies all is not well on the political front, and so does the public tiff between Mr Gordhan and Tom Moyane, the South African Revenue Service (SARS) commissioner.
Mr Moyane was absent from the news briefing on Wednesday; when asked about this, Mr Gordhan said: “It’s no secret that there are issues to resolve at SARS. We will resolve them in a couple of weeks and then we will communicate to the public.” The way these issues are resolved – and it is widely understood that the main issue is that Mr Moyane, who is close to Mr Zuma, is resisting taking orders from Treasury – will make a difference to investors’ opinion of the Budget’s credibility.
Contrary to expectations, Mr Gordhan did not increase personal income tax or Value Added Tax (VAT) – concentrating instead on several indirect taxes that will increase the overall tax obligation significantly if not always obviously.
On a political level, the budget is likely to attract criticism from the left of the political spectrum and has already attracted criticism from the right. For the political left, the failure to increase the tax obligations of the rich was a missed opportunity while the more conservative will soon factor in the real cost of the indirect tax increases and the negative impact on economic growth.
People in the centre will probably tend not to have very strong opinions about it – they will just be left a little poorer.
Mr Gordhan did the best he could given the political constraints that limit his choices and it perhaps says something when both Gwede Mantashe – the Secretary General of the ruling African National Congress (ANC) and a member of the SA Communist Party (SACP) – and the leader of the Economic Freedom Fighters (EFF) Julius Malema, who is usually opposed to anything coming from the African National Congress (ANC), both welcomed the gist of the Budget.
The Budget aims to add R48bn to tax revenue over the next three years. Crucially, only R18.1bn of this will stem from the tax proposals highlighted in Mr Gordhan’s speech yesterday. The Budget states that a “series of interventions will add R15bn to revenue – over and above baseline forecasts – in each of the subsequent two years… The nature of interventions in the two outer years will be subject to further work and development.”
Thus government is planning to increase revenue by billions of rands and close the budget deficit much quicker than previously projected, but it cannot tell us how just yet.
Worryingly, this issue did not slip by the rating agencies. Moody’s Investors Service’s senior vice president Kristin Lindow yesterday highlighted that the budget lacked specific details on cutting the deficit.
However, on page 42 of the Budget Review, the Treasury gives us a clue as to what to expect: “a recent World Bank report concluded that VAT and fuel levies are mildly progressive in South Africa … In future, the balance between taxes on income (direct taxes) and consumption (indirect taxes) will be an important consideration in ensuring a diversified, efficient, equitable and sustainable tax system. The current tax mix suggests that there may be greater room to increase indirect taxes, such as VAT.”
Turning his attention to the rating agencies (if indirectly) Mr Gordhan indicated that government would reduce the expenditure ceiling by R25bn over the next three years – apparently targeting personnel spending including elements such as freezing non-critical vacant posts, reducing staff, controlling compensation pay-outs (apparently no more millions for sacked officials at the national broadcaster), and limiting the use of contract staff.
That could be politically difficult given that the only sector to show significant employment growth over the past few years has been the public sector – adding jobs to state departments at all levels and to the complement of State Owned Enterprises (SOEs) has been a key government strategy to boost employment and meet targets.
Now the Treasury wants to curtail this practice, but there does not appear to be any real implementation mechanism to ensure its directives are in fact followed.
In addition, what tends to happen when Treasury curtails expenditure is that second and third tier departments and structures suffer most while the bloated national level makes only minor adjustments, passing the burden to the lower levels of government.
This is problematic on two levels. Firstly, it is not that easy to keep track of spending at local and provincial levels and excesses and waste are usually only detected after the fact. Secondly, at the overtly political level it leaves second and third tier structures to make the unpopular decisions that flow from spending cuts.
That deflects anger away from the national level but creates problems and tensions at the lower levels of government, as service delivery deteriorates and constituents protest in anger.
According to the Treasury, 2016/17 revenue is expected to come in at R1,324bn, about 8.3% more than in 2015/16. On the expenditure side, despite the above-mentioned R25bn lowering of the expenditure ceiling for recurrent expenditure, total expenditure increased by about 6% y-o-y to R1,463bn in 2016/17.
Thus, the National Treasury expects to record a budget deficit of 3.2% of GDP in the 2016/17 financial year, from a preliminary shortfall of 3.9% of GDP in 2015/16, and aims to bring the deficit down to 2.4% of GDP by 2018/19.
Another worrying fact is that the expenditure category expected to grow the fastest over the forecast period is debt-service cost. Debt-service costs are expected to grow at an average pace of 11.4% p.a. during 2015/16 – 2018/19, compared to the average growth in total consolidated expenditure of 7.1% p.a. over the corresponding period. In total, debt-service costs were revised up by R18bn from 2015/16 to 2017/18.
As a result, debt-service costs are expected to increase from 3.2% of GDP in 2015/16 to 3.5% of GDP in 2018/19. This is due to the rapid depreciation of the rand and rising interest rates (partly due to Mr Zuma’s game of musical chairs at the National Treasury in December).
According to the Treasury, the ailing rand resulted in the stock of foreign debt rising by R45bn in 2015/16. As a result, net public debt will stabilise at 46.2% of GDP in 2017/18, compared to 45.7% of GDP in 2019/20 as was envisaged only four months ago when then-Finance Minister Nhlanhla Nene presented the Medium Term Budget Policy Statement (MTBPS).
Earlier this month we suggested that a rating downgrade would likely not trigger massive capital outflows out of South Africa as such a move has largely been priced in already. However, should South Africa follow in Brazil’s footsteps by being downgraded to ‘junk status’ we expect there to be a degree of upward pressure on bond yields, further exacerbating the debt-servicing cost burden.
Mr Gordhan did what he could within the limits of his ability to manoeuvre between economic demands and political constraints, and the deep fundamental economic reforms needed to lift growth levels well above a miserable projection of 0.9% are seemingly out of his hands.
What Mr Gordhan could not address was the disjointed and ideologically hobbled economic policy that is the root of the problem.
While he did as good a job as could be expected, Mr Gordhan will perhaps fall short on the big objective of the Budget – staving off a ratings downgrade. Over the next few days, the future will become a little clearer but the downgrade remains in the balance if not now then within months.
A key element over the next few days will be how the Budget is reviewed and interpreted by various political parties and by the various factions within the ANC and the broader alliance. If there is the slightest indication that Mr Gordhan does not have the full support and backing of his government colleagues and key elements of the party and the alliance, then all bets are off.
Gary van Staden (Senior Political Analyst) & Bart Stemmet (Senior Economist)
