The 2017 Budget retains a commitment to narrowing the budget deficit to an internationally acceptable level of 2.6 percent of gross domestic product (GDP) over the medium term and stabilising the government debt-to-GDP ratio through a combination of tax increases and slower growth in overall spending (with outright cuts in some areas).
Fiscal consolidation will hurt the economy in the short run, but is necessary to maintain an investment-grade credit rating. Fortunately, unlike the previous four years, the 2017 Budget comes against a more favourable global climate (firmer commodity prices and positive sentiment towards emerging markets) and a somewhat improved local economic outlook. In the short term, fiscal consolidation is a drag on economic growth, but should not derail the recovery. What are the other implications?
It is important to remember that a “good” Budget for investors and ratings agencies is not necessarily good for consumers, as it ultimately involves the South African Revenue Service sticking its fingers deeper into their pockets.
This includes an additional R12 billion in tax revenue for not compensating for bracket creep - ie an inflation-related wage or salary increase pushing the taxpayer into a higher tax bracket. This affects the middle class most.
There was also a fuel levy increase that is expected to raise R3 billion and the usual sin tax hikes. An additional R4.4 billion is expected to be raised from the new 45 percent top marginal tax bracket (the wealthy tend to spend a smaller proportion of income and therefore the impact on overall consumer spending will be lower). The increase in dividend withholding tax, which is expected to net R6.8 billion, will probably impact savings more than spending.
Welfare grants will be increased in line with inflation, so there will be no impact on real spending.
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All of this will erode households’ disposable income, but the additional R28 billion tax burden represents only about 1 percent of the R2.6 trillion annual household consumption spending. Declining inflation should offset the negative impact on real disposable income to an extent, which also means that the interest rate outlook is more favourable. Tighter fiscal policy could allow for some loosening of monetary policy.
Bonds
A “good” Budget is necessary, but not by itself sufficient for securing South Africa’s investment-grade credit rating. Political stability and faster economic growth will also be required.
But yesterday’s Budget is likely to be the first step in maintaining current ratings, with tough tax measures in difficult economic conditions showing determination and commitment.
Such commitment to prudence is positive for bonds as it caps the new supply of bonds and therefore supports prices. Fiscal consolidation tends to put downward pressure on inflation, making it more likely that the South African Reserve Bank will consider interest rate cuts, which is a further positive for domestic bonds.
Equities
The company tax rate was left unchanged, so there is no impact on after-tax profits. Since the intention to increase tax revenue was announced in October last year, it is likely to already be discounted in the share prices of domestically focused companies.
The increase in dividend withholding tax will reduce overall equity returns marginally, but over time, global market developments are more likely to drive the JSE than the Budget speech’s outcome.
Rand
The rand has appreciated sharply over the past year, despite global and local political uncertainty and the risk of ratings downgrades.
The primary driver of the rand is likely to remain commodity prices, sentiment towards emerging market and expectations for US interest rate increases.
The Budget is unlikely to change this, but should Finance Minister Pravin Gordhan be removed from his post, it would add to short-term rand volatility.
Dave Mohr is the chief investment strategist at Old Mutual Wealth.