Five challenges Gordhan faces

Finance Minister Pravin Gordhan faces what could be his most difficult budget speech to date as he seeks to stimulate the economy while containing expenditure.

Gordhan is expected to present the Medium Term Budget Policy Statement (MTBPS) to Parliament on October 26.

Finance Minister Pravin Gordhan. File picture: Waldo Swiegers. Credit: BLOOMBERG

The minister's need to carefully balance raising revenue, likely through new taxes, while also attempting to contain expenditure in an environment characterised by low economic growth seems to become more of a challenge with each budget speech.

This has been made even harder this year due to current factors such as the tertiary education funding debate, the threat of a sovereign ratings downgrade and the minister's pending court appearance on a charge of fraud.

There are five key challenges facing the minister in the MTBPS:

Weak GDP growth and an appropriate turnaround strategy

On October 4, the International Monetary Fund once again cut South Africa's gross domestic product growth forecast in 2017 to 0.8 percent, from 1 percent previously. Growth during 2016 is expected to be marginal.

Downward GDP growth revisions have become a consistent pattern, as the consumption-led, debt-financed economic growth of recent years has reached its limits.

The persistent downward revisions of GDP growth in recent years is partly due to a weaker economic environment globally but is also driven by various challenges facing South Africa, including political uncertainty and investor concerns.

Weak economic performance has put pressure on the budget deficit and revenue is insufficient to cover expenditure. Minister Gordhan will need to present viable strategies to tackle this challenge in the MTBPS.

Sustained budget deficits

In his 2016 budget speech, Gordhan said the budget deficit will fall from 3.2 percent of GDP in the 2016/17 year to 2.4 percent in 2018/19.

This would be a positive development because each year the deficit adds to a country's sovereign debt, resulting in higher debt servicing costs, which could better be utilised to stimulate the economy. Reducing the budget deficit can be achieved through increasing revenue and reducing expenditure.

Meaningful growth in tax revenue will only be achieved if there is a reasonable pick-up in economic growth, which is only possible if there is further infrastructural activity and job creation. We need policies that make it attractive for international and local companies to invest in South Africa, and confidence that these policies will not change unexpectedly.

National Treasury has been focusing on expenditure cuts, highlighting the urgency of restoring the fiscal position.

Whether meaningful expenditure savings is achievable remains to be seen, with any overspend a potential risk to the sovereign credit rating, given that the shortfall will have to be funded through additional debt, and a commensurate rise in interest costs.

Containment of government debt

Persistent budget deficits since 2008 have necessitated the need for government to continue funding the shortfall through raising new debt each year.

In February, Gordhan said it was a "central objective" to stabilise debt as a percentage of GDP. Through reduced spending, he projected net national debt to stabilise at 46.2 percent of GDP in 2017/18 and to decline after that.

Higher debt levels can make it more difficult for the government to raise funds, as the debt to GDP ratio continues to increase, creditors (and rating agencies) become concerned about a country's ability to repay its debt, demanding higher interest rates to compensate for the higher risk.

This has an impact on the budget deficit each year, which if sustained by a country issuing increasing debt over a prolonged period has the potential to lead to a vicious cycle that would see it go deeper into debt to repay existing debt.

The current account deficit

A country's current account measures the difference between the value of exports of goods and services and the value of imports of goods and services. A deficit means that the country is importing more goods and services than it is exporting.

South Africa's current account deficit shrank from 5.3 percent of GDP in the first quarter of 2016, to 3.1 percent of GDP in the second quarter.

While this is a positive short term movement, South Africa's current account deficit has remained persistent and relatively large over recent years. In the long run, a protracted current account deficit has negative ramifications, as foreign investors question whether economic growth can provide an adequate return on their investment. Currency depreciation sees their rand holdings worth less in foreign currency over time.

Political uncertainty

Government's ability to meet the various targets as set out in its budgets is a key qualitative measurement of the country's leadership and is one of the aspects taken into account by rating agencies.

Government needs to demonstrate that economic growth forecasts and deficit reduction targets between 2017 and 2019 are attainable. This is also very important in terms of assessing whether Minister Gordhan has the support of government because as long as there is political uncertainty, there is unlikely to be meaningful economic growth or job creation.

Rating agencies have specific parameters for their ratings bands and if government deviates outside these parameters, this could trigger rating movements.

Adverse political amendments, such as a sudden and unexpected replacement of the finance minister, have the potential to impact on all the primary quantitative measures assessed by rating agencies, and would be a cause of significant concern for investors.

It is important, now more than ever, for government, labour and business to work together to find and successfully implement solutions to South Africa's challenges.

Marc Joffe is CEO of Global Credit Ratings. His opinions do not necessarily reflect those of IOL.

We'll have you covered for all the relevant budget news on the big day; pick up a copy of Business Report on October 27 for analysis and insight.