The Medium-Term Budget Policy Statement (MTBPS) as presented by Minister of Finance, Tito Mboweni last, was given against the realisation of the staggering impact State Capture had on the South African economy, strained fiscal numbers and ongoing concerns regarding the risks of further credit rating downgrades.
Was Mr Mboweni able to address the glaring revenue shortfalls, ever-increasing debt to GDP and strain of state-owned enterprises (SOE’s) on the fiscus?
Kemp Munnik, Head of Structured Solutions at Bravura, an independent investment banking firm specialising in corporate finance and structured solutions, re-looks at those key aspects which came out of the mid-term budget policy statement (MTBPS), and which should guide Mboweni’s roadmap for Budget 2019. The MTBPS framework is significant because it provides insight into planned government expenditure and indicates expected tax increases that South African taxpayers may have to face. It also informs decisions of the credit rating agencies about South Africa’s fiscal stability.
Revision of growth forecast
South Africa’s economy is shrinking, with unemployment at a 14-year high of 27.7% (or 37.2% if the definition of unemployed is expanded to include those too discouraged to look for work).
The South African Reserve Bank announced earlier this year that SA is in a technical recession following two consecutive quarters of negative growth.
In the MTBPS, the National Treasury forecasts that GDP growth will slow to 0.7% in 2018, down from 1.3% in 2017, before rising to 1.7% in 2019 and 2.1% in 2020.
The global economy is expected to continue growing at 3.7% in 2018 and 2019, although global risks are becoming more pronounced.
Revenue shortfall and significant increase in budget deficit
The MTBPS states that in 2017/18, for the first time since the 2008 global financial crisis, tax revenue growth did not exceed GDP growth.
Revenue shortfalls have widened over the past four years, with under-collections rising from R7.4 billion in 2014/15 to R49 billion in 2017/18.
The MTBPS announced that there will be a revenue shortfall of R27.4 billion, relative to the 2018 Budget estimate. This is due to weaker economic growth, alongside a once-off payment of overdue VAT refunds.
These revenue shortfalls lead to budget deficits. The MTBPS states that the 2018/19 consolidated budget deficit is estimated to widen to 4.3% of GDP. This is by far the highest level ever seen since 2008.
A glimmer of hope – no increases in taxes
The MTBPS states that increases in the major tax instruments would be avoided unless the economic environment requires it. At this stage, revenue projections assume no changes to tax rates, but provide for annual adjustments to personal income tax brackets, levies and excise duties in line with inflation.
In a significant step, the 2018 Budget released in February recognised that a corporate tax rate of 28% is affecting South Africa’s global competitiveness. The world experiences falling corporate income tax rates in advanced and middle-income countries.
The global trend to reduce corporate income tax rates includes countries that maintain strong investment and trading ties with South Africa. The United States, for example has reduced its rate from 35% to 21%, the Netherlands from 26% to 21%, and the United Kingdom from 30% to 19%. China’s corporate income tax rate is 25%.
Reducing the corporate tax rate would act as a stimulus to the South African economy. It should entice businesses to invest in new products, new projects and new ventures. The longer-term benefits will therefore be significant. This makes it something that Ramaphosa should give serious consideration to as he looks for ways to attract more investment.
If government expenditure exceeds revenue, the difference must be borrowed, which adds to the level of government debt. This implies that the government’s burden on the economy (total government debt as percentage of gross domestic product) will increase. Certain economists have commented that SA has entered an unsustainable debt spiral.
The MTBPS expects gross loan debt to increase to 55.8% of GDP in 2018/19. Debt is expected to stabilise at 59.6% of GDP in 2023/24. South Africa’s fiscal position is therefore substantially weaker than it was at the time of the 2008 financial crisis, when South Africa had a gross debt-to-GDP ratio that was just above 26%.
No savings in public sector wage bill
Treasury admitted in September this year that the contraction of public finances is placing tremendous stress on government and its ability to finance public services and this threatens the affordability of planned expenditure. A budget deficit requires government to make tough decisions regarding cost expenditure.
It does not seem as if the government has the stomach to do this. Perhaps the biggest concern is the ever-growing public sector bill. The MTBPS states: “The compensation of public servants accounts for a large and growing proportion of consolidated spending. Compensation spending was one of the fastest-growing items in the budget, increasing at an average of 11.2% a year.”
According to the Organisation for Economic Cooperation and Development (2017), South Africa’s government wage bill is one of the highest among developing countries country peers. The consolidated wage bill increased rapidly from 32.9% of spending in 2007/8 and remains at about 35% of total expenditure.
A three-year wage public service wage agreement was announced on 8 June 2018. The wage agreement was implemented with effect from 1 April 2018 and covers the period 2018/19 to 2020/21. Most public service workers will receive at least 0,5% to 1% above inflation over each of these three periods.
SAA and South African Post Office receive nearly R8 billion in additional funding
State-owned enterprises like Eskom and SAA have been an enormous drain on government resources. The roughly 55% debt-to-GDP ratio masks an additional 15% debt in government guarantees for SOEs, an obligation that the government cannot shy away from. The financial recovery of SOEs is therefore key to getting economic growth and investor confidence back on track.
The MTBPS recognises that: “Several entities with acute financial difficulties do not have sufficient cash to repay debt falling due. Ordinarily these institutions would refinance these amounts but given negative investor sentiment there is a strong possibility that they will have to redeem this debt.”
The MTBPS issues a severe warning: “The quality of public expenditure is often poor and governance problems are often severe, particularly in provincial and local government, and state-owned companies. Government is tackling these problems. … In the interim, however, distressed institutions at all levels of the public sector are risks to the public finances.”
Government had an opportunity to reinforce confidence and contribute to a recovery in growth and investment in the 2018 MTBPS, and to steer South Africa’s economic fortunes in the right direction. As we approach Budget 2019, Corporate South Africa is still holding its breath.