In the last medium-term budget policy statement (MTBPS) in October last year, the National Treasury projected real gross domestic product (GDP) growth of 3 percent this year. This was a downgrade from its previous estimate and it will be lowered again, but probably not as much as the markets may think.
Because the Treasury runs its macro projections in advance of its budget calculations, it will reflect the macro thinking from early last month, before the consensual GDP downgrade in the latest Reuters Econometer (figure 1). Also, the Treasury does not factor a hiking cycle into its forecasts.
Our forecasts are on the low side of the Reuters consensus, with the economy growing 2.4 percent this year (down from a previous projection of 2.8 percent). The downgrade comes as a result of higher inflation and tighter monetary policy compromising household consumption growth and private sector fixed investment.
The sorry state of business confidence means the latter may hold more downside risk than we have factored in. The upward move in GDP versus 1.9 percent last year, however, is mostly due to improved export performance thanks to currency weakness since 2011, though we do also factor in the continued efforts of the government to spend on services and infrastructure. We therefore expect the Treasury to downgrade its GDP forecast for this year and next year, to somewhere in line with the SA Reserve Bank: 2.8 percent for this year and 3 percent for next year.
Other than adjusting its GDP forecasts, the Treasury will revise up its inflation view. From 5.6 percent at the time of the MTBPS, currency weakness and food inflation will push the Treasury’s consumer price index (CPI) inflation estimate for this year to somewhere around 6 percent (Reserve Bank: 6.3 percent) and higher for next year than its 5.4 percent expectation.
The Treasury’s current account deficit estimates are likely to narrow through its forecast period. While a deficit of 6.5 percent of GDP may have been a fair assessment for the 2013 current account, we expect it to revise its 2014 to 2016 current account deficit ratios smaller. This is because trade figures have since been revised (for the better given the inclusion of the trade with Botswana, Lesotho, Namibia and Swaziland) and the fourth quarter provided a clear signal that a better export response and some import compression was occurring.
But it is nominal GDP that matters most when it comes to projecting revenue collection. Using CPI as a proxy for the potential direction of the Treasury’s GDP deflator, we see that the upgrades to the consensus on CPI have been smaller (plus 0.25 percentage points) than the downgrades to the consensus on GDP (minus 0.3 percentage points). As a result, this should leave nominal growth estimates only slightly lower this calendar year.
For the outer years, the Treasury built in some room in October by presenting a nominal GDP trajectory more downbeat than usual. This has helped it break away from the tendency of underestimating the slow pace of narrowing in the budget deficit over the forecast period.
For example, while nominal GDP in the 2014/15 fiscal year is likely to be downgraded, the 2015/16 fiscal year is a fair assessment of nominal GDP and the following fiscal year, 2016/17, may well be too low. This is a sound reason to not get too pessimistic.
Current fiscal year on track – Year to date, the nine months of revenue collection in this fiscal year are running ahead of the historical average. Income tax, corporate tax (which includes secondary tax on companies and dividend tax in our calculations) and all other revenue is ahead of target. The only underperforming revenue stream is VAT. Assuming expenditure doesn’t change, this leaves the main budget deficit meeting its October MTBPS target of 4.8 percent of GDP.
Outer years a mixed bag – Given our expectation for a downgrade to its 2014/15 nominal GDP forecast, we expect the main budget deficit to widen to 5 percent of GDP from 4.8 percent at the time of the MTBPS. For 2015/16, we think the estimate of 4.4 percent previously is fairly reasonable (we look for 4.5 percent); and for 2016/17, the main budget deficit is likely to narrow more than the Treasury projected in October (to 3.4 percent versus 3.6 percent).
Rating agencies agreeable with fiscal consolidation – What matters to the sovereign rating is that the agencies believe the Treasury is on a path of fiscal consolidation. If a budget deficit similar to our projections is presented, we believe this would be positive (even if the 2014/15 fiscal year sees the deficit widening). Alongside the Reserce Bank’s proactive January rate hike, this would minimise the likelihood of a ratings downgrade this year.
Public sector avoids a strike – If the Treasury revises its CPI projections higher (which we see as likely) then the final year of the public sector wage agreement should see a 7 percent increase – in line with the wage increases of the first and second years. While this may avoid a potential reopening of the wage agreement prior to the elections, we caution that the next agreement will be pinned off a higher inflation trajectory.
The national Budget last year announced that the government would initiate a tax review “to assess the tax policy framework and its role in supporting the objectives of inclusive growth, employment, development and fiscal sustainability”.
The review is under way, though it is not known when preliminary results will be released. The Davis tax committee was put together in July last year, but it will take more than a year to assess all the tax structures.
Nevertheless, the market is looking for indications as to when a final announcement on potential tax changes could occur, and what types of taxes are most likely to be adjusted and/or introduced. In its first public release, the committee’s terms of reference document lays out the key areas it is investigating – from the overall tax base to the appropriate tax mix to the sustainability of the tax-to-GDP ratio. We know that the head of the tax committee, Judge Dennis Davis, has stated that growth in small businesses is a top priority.
Markets would be concerned if fiscal policy took a swing to the left, but we do put a reasonable probability on a possible wealth tax that targets the upper end of the consumer income chain. Figure 8 suggests that for this income bracket, tax revenue has the most to gain. To boot, it would result in the fewest disappointed individuals.
A key risk, however, is capital risk.