File photo: Elmond Jiyane

The downgrade of South Africa’s sovereign credit rating by global ratings agency, Standard and Poor’s, is likely to result in spending cuts being made to South Africa’s already stressed budget.

The 2017 budget has been drawn up based on a particular scenario. That scenario has now changed significantly after the S&P downgrade. The proportion of the Budget devoted to debt servicing is already a cause for concern. In order to afford the higher interest rate, based on the presently projected income, government will simply have to borrow less.

One implication is that there will have to be cuts on the expenditure side, which has the potential to severely impact service delivery. The reduction in service delivery will have a detrimental impact on all consumers, which may be exacerbated for the less affluent parts of our community.

The proposed introduction of a National Health Insurance system is expected to be the first to suffer setbacks. Government is also under pressure to provide greater subsidy for tertiary education. The ability to do so will now be severely limited unless major cuts are made to expenditure in other areas.

Treasury will possibly attempt to increase its income by increasing taxes further.

More taxes

The scope for increasing income taxes is extremely limited, however. We saw limited adjustments to compensate for ‘bracket creep’ in the Budget as well as the introduction of a new 45 percent top marginal rate for individuals. Companies are now also being taxed at the upper end of corporate income tax rates worldwide.

An increase in the standard rate of Value-Added Tax and removing the zero-rating of fuel would seem to be among the few remaining options that Treasury will have to consider.

There are two ways in which removing the zero rating could be approached. 

The supply of fuel could become standard rated or it could become an exempt supply. If fuel becomes standard rated, the direct effect will be an immediate increase in the pump price of fuel of 14 percent. Transport costs will rise significantly for private vehicle and public transport users alike.

There should not be a material effect on prices of consumer goods and services as businesses that are VAT vendors will be entitled to claim the additional VAT paid as input tax.

The less probable scenario of making fuel an exempt supply will result in the fuel companies not being entitled to claim input tax relating to fuel.

This will increase their operating costs, which may be partly compensated for by an increase in the margin for fuel retailers. This would result in a far reduced additional tax take for government and create a complex apportionment scenario for many businesses.

Read also: S&P first to give SA 'junk' rating

What is certain, is that the major reversal in the exchange rate of the rand will greatly increase the prices of fuel imports. This will hit beleaguered consumers hard. One could also see reduced corporate profits, resulting in a reduced corporate tax take. 

Of course, there may be some businesses that find a depressed rand value to be to their advantage. Exporters whose goods are priced in foreign currency will derive higher rand prices. They can also potentially afford to drop their export prices to become more competitive and break into other markets.

A further implication is that we are likely to see higher interest rates – further placing most businesses and consumers under additional strain. Overall the outlook is somewhat gloomy.

Major tax changes at the time of the mid-term 2017 Budget are not probable. But we are presently in uncharted waters and we may well see some changes coming through this year. The need for fiscal discipline has to be balanced against the perception of panic.

If inflation does skyrocket this year, it is almost certain that the 2018 Budget will see the removal of the zero-rating of fuel for VAT purposes, and possibly an increase in the standard rate of VAT. Further expenditure cuts and the fast-tracked introduction of new taxes may also become distinct possibilities.

Read also: Rand slides on S&P credit rating cut

The road back to an investment grade rating may be long and bumpy. Some of the key areas to shorten the ride and make it less bumpy will include political stability and the introduction of measures to stimulate growth.

Bernard Sacks is a Partner at Mazars. His opinions do not necessarily reflect those of Independent Media.