Most of us have had time to digest the budget, specifically how the R28 billion increase in the tax burden that largely falls on individuals will impact us. The new top marginal tax bracket of 45 percent applies to 103000 taxpayers, who will, on average, pay R3 500 a month more in income tax.
There are 7.4 million registered individual taxpayers in South Africa, but 6.5 million fall below the threshold income and don’t pay income tax.
The immediate market reaction to the budget was fairly positive. One wouldn’t expect a big reaction from the markets, because the mini budget in October had already provided clear direction; last week was just a case of giving us the details.
The 2017 budget retains a commitment to narrowing the budget deficit to an internationally acceptable level of 2.6 percent of gross domestic product (GDP) over the medium term and stabilising the government’s debt-to-GDP ratio. Fortunately, unlike the past four years, the global climate is more favourable this year.
Global economic activity is speeding up, particularly in Europe, where economic growth has reached its fastest rate in six years. Commodity prices have firmed substantially over the past year, and investor sentiment towards emerging markets has improved, reversing the sustained capital outflows of the past five years.
When Finance Minister Pravin Gordhan delivered the budget speech last year, the rand was at R15.26 against the US dollar. Last week, it closed at R12.94.
South Africa benefits from all these trends, and the local economic outlook has therefore improved. In the short term, fiscal consolidation is a drag on economic growth, but it should not derail this recovery.
Whereas the economy barely grew in real terms last year, National Treasury expects growth to rise to 2.2 percent over the next three years. These numbers represent an improvement off a low base, however, and will not dent the unemployment rate.
Perhaps the biggest criticism of the budget was the lack of reform announcements and measures to stimulate growth. But it is important to remember that the Minister of Finance and National Treasury control the government finances, not economic policy.
Ratings reprieve hurdles
Consider the ratings outlook, for instance. In a recent panel discussion, S&P Global’s local representative reiterated that South Africa’s ratings hinge on three issues. First, expectations of an improvement in economic growth and fiscal performance. Second, signs of weakening institutions would put downward pressure on ratings, because they could lead to a deteriorating investment climate. Third, the risks posed to government’s finances by state-owned enterprises (SOEs).
Of the above, Gordhan has direct control over only fiscal performance, and even in that case not as much as he would like. The overall thrust of fiscal policy is a cabinet decision, not Treasury’s alone. But the outcome of fiscal policy is dependent on the performance of the economy.
The problem over the past four years has been that the weak economy has put tax revenue under pressure. Complicating matters somewhat is that the economy responds to fiscal policy too. For instance, sharp tax hikes could choke off the nascent recovery. On the other hand, tax incentives can encourage growth and job creation in targeted sectors.
South Africa’s institutional strength was stress-tested last year. When flimsy charges were brought against Gordhan, the combination of media freedom, a vibrant civil society and independent courts prevailed.
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And our central bank was willing to hike rates to maintain its inflation fighting credentials even though there was an election around the corner. The election itself and the subsequent peaceful transfer of power in key metros also demonstrated the strength of our institutions.
In terms of the SOEs, there is some control by the Treasury, because it signs the guarantees that make up the government’s contingent liabilities of about 10 percent of GDP. But the overall structure, objectives and governance of the SOEs rests with the cabinet, not the Treasury. The financial underperformance of the large SOEs - the return on equity of the 16 largest SOEs in the 2015/16 fiscal year was only 0.8 percent, well below any reasonable estimate of the cost of capital - is not only a drag on the fiscus, but it can also hamper economic growth.
It is also important not to lose sight of South Africa’s ratings strengths. These include world-class financial markets and a well-capitalised banking sector. The government is therefore not dependent on borrowing in fickle foreign markets, exposing it to currency swings (foreign debt is only 10percent of the total of R2trillion).
As long as economic growth improves in the short term, and provided there is no institutional deterioration, South Africa can hold on to its investment-grade rating. This would be a positive surprise, given that global-market pricing places us in the same camp as “junk” economies such as Russia and Brazil.
Structural reform needed
Faster economic growth over the longer term is not only important for job creation, but it is also necessary for fiscal sustainability, because it will lead to growing tax revenues, which the government can spend on welfare, education and health without resorting to additional borrowing.
Structural reforms to lift the long-term growth rate include lowering barriers of entry to increase competition among firms, providing young people with easier access to the job market, ensuring fewer strikes, improving transport infrastructure, attracting skilled immigrants until our own people are better equipped, effective land reform and greater regulatory certainty, particularly in capital-intensive industries such as mining.
The Budget Review highlights that 2016 was the first year in which private fixed investment contracted since the global recession, a sign of rock-bottom confidence.
It lists a number of items on the government’s to-do list that could lift investment (including finalising mining regulation, expanding the independent power programme and concluding analogue-to-digital migration), the responsibility for which rests with departments other than the Treasury.
Unsaid, of course, is the lack of certainty over Gordhan’s position, which has drained business and investor confidence over the past 14 months.
Dave Mohr is the chief investment strategist and Izak Odendaal is an investment strategist at Old Mutual Multi-Managers.