The budget has to deal with one big question: what is to be done about the implications of such a weak rand (high infrastructure and debt service costs)?
The answer, however, is likely to be within the broader framework of an ongoing departmental spending freeze, good revenue performance, and underspending – basically a continuation of the “boring and conservative” macro line. As a result there will be, in our view, a slowdown in the pace of investment spending within the Budget, although some can probably be offset through efficiency savings.
We think there are unlikely to be any big announcements or tax changes given the upcoming election, with the exception probably of a few small political give aways that won’t be significant in the top-down picture. Given this, rating agencies are likely to be cautiously constructive on the outcome, although we still think downgrades could happen towards the end of the year. The outcome should also be marginally constructive for the bond market.
Last year’s Budget highlighted the conundrum of the country’s fiscus: seemingly stable on the surface, but a lack of momentum beneath that couples with downside tail risks. That fact remains unchanged; however, revenue performance surprised to the upside into December given a quieter strike season than expected, which means difficult choices are less difficult this time before the election.
This revenue performance will combine with the usual rate of underspend and budget reserve buffers and higher nominal growth numbers and will result in likely shifts up to the Treasury’s gross domestic product (GDP) deflator assumptions. This means there will be a small amount of money to play with. It may amount to about R15 billion.
Part of this will be given away in small pre-election political “treats” – education and jobs likely being the focus. But this will make no real difference to the macro top-down budget view. The key use of this gap will be on higher infrastructure costs as a result of the weaker rand.
The public sector programme is much more import-reliant than the government programme, however, so we are talking probably about a R5bn odd increase in costs per year as a result of the rand’s 20 percent fall since last year’s Budget. However, we do not think the government will bail out such cost increases based on our previous talks with the Treasury and parastatals. The Budget, in our view, will instead direct a smaller amount to cover the increased costs for the government infrastructure programme. Add to that another R1.2bn in foreign exchange debt coupon payments for the coming fiscal year and another R1.8bn in principal payments of foreign exchange debt. However, we can see that all this does fit into the existing budget framework without upset.
The implication of not supporting the wider public sector will be a slower build pace and possibly a small attempt at increased public sector bond issuance, which together will not be growth positive. The message will be to reinforce the existing slow, capacity-constrained infrastructure build pace – the spend is huge, but its growth will be zero basically because of financial and capacity/skills constraints.
More broadly, we expect very little to occur on the tax front. Some expect there to be some preliminary results from the Davis tax review, but given this is likely to point to the need for a broadening of the revenue base and the inability for this to occur before the election, we think it’s unlikely we will get anything meaningful on this front. No changes are expected to taxes except usual inflation adjustments on the personal side and not on the corporate side to allow for revenue creep.
Recent increases to social grants will be highlighted, but we don’t think there is room at this Budget to offer anything new on this front, despite the election. The usual sin tax increases are expected.
It’s unlikely there will be any major announcements on National Health Insurance (NHI) except to see more health-related spending brought under the NHI banner.
We expect the spending cap to remain in place for departments and still overly optimistic assumptions on public wages to be included given the increase in inflation. This will help to keep some wiggle room.
We expect no change to the Reserve Bank mandate and changes to capital controls are less likely given the volatile rand.
President Jacob Zuma’s State of the Nation address disappointed investors with the lack of forward-looking, positive vision for the economy. We think Finance Minister Pravin Gordhan will try and highlight the ANC’s achievements, but will also give a more positive forward-looking vision, cognisant of both the rating agencies and investors watching in this fragile market environment for emerging markets.
The National Development Plan will be front and centre and spending priorities highlighted along those lines. The youth wage subsidy will also be trumpeted.
We don’t expect any more interventionist, leftist, manifesto or Mangaung resolutions issues such as support for state involvement in sectors such as mining and pharmaceuticals. These factors must be watched after the election, but not now.
We believe that GDP growth will be revised down from 3 percent for this year and 3.2 percent for next year by about 0.2 percentage points to 0.3 percentage points to take into account lower global growth and the sluggish recovery locally. Inflation should be revised to be closer to 6 percent.
We think, given the factors outlined above, the deficit profile for this year and next can remain broadly in line with the medium-term budget policy statement. For future years, however, we think there is still too much optimism on growth numbers. As such, we see a much more gradual deficit reduction. We think the debt forecast profiles should increase further based on the currency weakness, but we don’t believe the underlying moves will be big.