2021 Budget Rubicon: Are pensions in the firing line?
By Chris Harmse
The 2021/22 Budget will be the real Rubicon of the state. The government has no more room to move and has no choice but to take bold steps, not only due to possible new risks, but also to address the risks in the economy that already became pandemic.
Finance Minister Tito Mboweni has the daunting task of balancing income and expenditure without putting further pressure on the current unaccepted government debt-to-gross domestic production (GDP), which already is close to 90 percent of GDP.
In doing so, he also will have to finance the roll out of the Covid-19 vaccine programme, provide further bail-out finances for state-owned enterprises (SOEs), address the government’s unacceptably high salary account and introduce unpopular tax proposals.
His biggest hurdle remains the effects of the current Covid-19 lockdown on the economy. The minister will have to anticipate how the vaccine programme will be implemented and its effects, how quickly the economy will be opened again and, from that, what possible effects these will have on the economy. Only then will he be able to give a realistic forecast of the economic growth rate for the year and, therefore, expected tax income.
The biggest challenge for this Budget will be to finance the expected deficit. On the one hand, he must take bold steps to lower government expenditure in actual terms and raise income to the extent that it does not harm economic growth. In raising income, what taxes will have to be raised and will he use prescribed assets from pension funds to finance the deficit?
Macro-economic expectations and challenges for the Budget
In its Medium-Term Budget Policy Statement (MTBPS), the National Treasury forecast that the South African economy would grow at 3.7 percent in 2021, 1.7 percent in 2022 and 1.5 percent in 2023 as the economy starts to recover after the Covid-19 pandemic.
These growth rates will not be enough to withstand further rises in the debt/GDP ratio. The government expects that the total gross loans to GDP will increase from 81.8 percent in 2020/21 to 92.3 percent in 2023/24.
The MTBS has indicated that the total expenditure is supposed to decrease in absolute nominal terms from R2 037 billion in 2020/21 to R1 993bn for this coming year, 2021/22. Even given the proposed cut in expenditure as well as a strong recovery in GDP economic growth 3.3 percent, debt to GDP will still increase to 85.6 percent.
According to the MTBPS, ”Achieving these targets will require large reductions in non-interest spending over the next three years, amounting to R300bn relative to projections set out in the 2020 Budget Review.“
The majority of these reductions will be applied to the wage bill. The government will aim to protect funding for infrastructure investment. To assist with the consolidation, the government has projected tax increases of R5bn in 2021/22. The fiscal outlook is highly uncertain.
Major risks include the speed of the economic recovery, the legal process associated with public-service compensation and the forthcoming wage negotiations. In the broader public sector, several SOEs and municipalities have insufficient funds to cover operational expenses.
These above risks become more and more a reality for the national Budget in February 2021.
Mboweni will have to adhere to a substantial cut in the wage bill and abstain from bailing out several SOEs. These steps seem to be politically unacceptable. Apart from this, he also will have to find ways to finance about R20bn for the Covid-19 vaccine.
In this scenario, one can expect that tax increases will have to be much more than R5bn. Given this reality, it may be possible that the minister will have to seek other sources of financing above VAT, company or personal income tax increases.
Apart from increasing the fuel levy, prescribed assets or investments for pension funds may be implemented. We, therefore, must be aware of these two possibilities.
Prescribed assets and your pension
Prescribed assets on pension funds in not a new concept and has been used in South Africa on various occasions. The concept arose during the 1970s and 1980s and at one stage South African pension funds had to invest as much as 77 percent of all their assets in prescribed government bonds and SOEs.
The big debate again now is if the government will introduce these forms of prescribed assets, or prescribed loans, or investments in, for instance, Eskom, the National Road Agency, SAA the Land Bank or even in infrastructure and other state-driven projects.
The government has the tools by making use of the current regulation 28 of the Pension Fund Act. Regulation 28 limits money managers’ allocation of retirement savings to certain asset classes, including equities, property and foreign assets. The overall objective is to protect consumers by restricting the allocation of investor funds to riskier assets on the one hand, but on the other hand to allow for the selection of more strategic and complex options. (Prudential Investment Managers, June 2017.) Under this rule, the government may enforce prescribed assets or even prescribed investments or loans.
If the Treasury introduces guaranteed bonds, as for instance a Covid-19 Bond as a prescribed asset for pension funds to finance the vaccines against the pandemic, it may not have a negative effect on returns on pension funds.
Government bonds will have a coupon rate, for instance 8 percent per annum, payable twice a year for 10 years, if it is a 10-year bond. Government bonds, for instance, were the best performing assets over the past two years with returns of around 8 percent per annum.
The danger remains if the government uses regulation 28 and prescribes direct investments into government investment projects and/or SOEs.
In such a case, no guarantee for returns will be applicable and can result in nothing other than a tax on pension funds. Although one can expect heavy resistance from the pension fund sector, as well as the labour unions, it can happen that the government will target the Government Employment Pension Fund (GEPF) first as they have total jurisdiction over the fund.
In June 2020 the Public Investment Corporation (PIC), which manages the GEPF, the biggest pension fund in the country, appointed Justice Yvonne Mokgoro to assist the state-owned asset manager to implement wide-ranging recommendations of a commission of inquiry into the PIC’s governance affairs.
The commission found large fee payments were made on deals to “privileged insiders” that often were former employees of the PIC. The commission also found that there was “impropriety” and “ineffective” governance in a number of investments.
Given the potential misuse of the GEPF, it poses a big threat if the minister moves in his Budget to impose prescribed investments and loans to certain state entities and or state investment projects.
Dr Chris Harmse is an economist at CH Economics