Current Finance Minister Malusi Gigaba delivered South Africa’s 2018 Budget in a more positive atmosphere given that Cyril Ramaphosa has been sworn in as State President last week. However, was he able to address the glaring revenue shortfalls, ever-increasing debt to GDP and threat of Moody’s following in the steps of Fitch and S&P Global with a downgrade of South Africa’s local debt to junk status?
Kemp Munnik, Head of Structured Solutions at Bravura, an independent investment banking firm specialising in corporate finance and structured solutions, comments that this Budget was keenly watched by local and international investors given the political change that took place recently, especially against the backdrop of the allegations of state capture. The 2018 Budget was essential to restore the credibility of the Annual Budget and the medium-term expenditure framework (MTEF).
The MTEF is significant because it provides insight into planned government expenditure and indicates expected tax increases that South African taxpayers have to face. It also informs decisions of the credit rating agencies about South Africa’s fiscal stability.
Revision of growth forecast
The South African economy has slowed down significantly in recent years. During the last quarter of 2016 and the first quarter of 2017 it even retracted into negative territory.
Gross domestic product growth of 1% is now expected for 2017, up from 0.7% projected in October 2017. The National Treasury projects real GDP growth of 1.5% in 2018, 1.8% in 2019 and 2.1% in 2020.
The economy has benefited from strong growth in agriculture, higher commodity prices and, in recent months, improving investor sentiment and a stronger rand.
The global economy continues to provide a supportive environment for expanded trade and investment. World economic growth is at its highest level since 2014 and continues to gather pace. GDP growth is rising across all major economies. The global economic recovery provides a supportive environment for South Africa to expand trade and investment, but domestic constraints that have reduced business confidence stand in the way of accelerated growth.
Revenue shortfall and increase in taxes
There have been revenue shortfalIs in four out of the past five fiscal years, mainly as a result of disappointing economic growth. The cumulative shortfall is about R60bn. The 2016/2017 shortfall was R30bn — the worst revenue performance since the global financial crisis.
Minister Gigaba has now announced a projected revenue shortfall of R48.2 billion in 2017/18, which is R2.6 billion less than the October 2017 estimate. He has therefore announced an increase in value-added tax from 14% to 15%. He will also maintain the top four personal income tax brackets with no inflationary adjustment to eliminate fiscal drag. These two measures will raise an additional R36 billion in 2018/19, enabling government to narrow the revenue gap.
The 2018 Budget proposals will increase the gross tax-to-GDP ratio from 25.9% in 2017/18 to 27.2% in 2020/21. Social grant payments will increase faster than inflation to offset the effect of higher taxes on poor households.
Recognition that corporate tax rate cannot be increased further
In a significant step, the 2018 Budget recognises 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. This trend limits the room to increase (or even maintain) the corporate tax rate. Corporate income tax contributes more as a share of GDP in South Africa than in most other countries. Within the Organisation for Economic Cooperation and Development (OECD), only companies in Chile contribute a higher share.
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%. While some African countries have similar or slightly higher tax rates, these are often effectively reduced with incentives and/or tax holidays.
The Budget Review recognises that South Africa is becoming an outlier, providing an unintended incentive for companies to shift profits abroad and pay lower taxes elsewhere. In recent years, government has taken steps to avoid erosion of the corporate tax base and prevent profit shifting, and to remove or redesign wasteful tax incentives. In addition to effective anti-avoidance legislation and adequate enforcement capacity, this requires policy decisions that do not undermine investment and competitiveness.
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 Budget Review recognises that increasing taxes in a low-growth context, when many South Africans are struggling to make ends meet, is not desirable. However, the fiscal position is 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%. That ratio now stands at 53.3%. A failure to act now would lead to more drastic spending cuts and tax increases in future.
Gross loan debt, which in the October 2017 projections was set to breach 60% in 2021/22, is now projected to stabilise at 56.2% by 2022/23. The combination of higher GDP growth, a narrower deficit, a stronger currency and lower borrowing rates results in this improved debt-to-GDP outlook.
In November 2017, in response to the deteriorating fiscal outlook, a Cabinet sub-committee identified medium-term spending cuts amounting to R85 billion. About R53 billions of this amount has been cut at national government level, including large programmes and transfers to public entities. At subnational level, conditional infrastructure grants of provincial and local government have been reduced by R28 billion. In addition, all national and provincial departments were required to reduce their spending on administration. The reductions exclude compensation of employees, which is already subject to a ceiling.
Recognition that cut in public sector wage bill is required
Government recognises the need to shift spending away from consumption towards capital investment.
To support higher levels of capital investment, the state needs to contain the public-service wage bill, which has crowded out spending in other areas. The level and rate of growth in remuneration is of concern. Cost-of-living adjustments that consistently exceed consumer price inflation continue to put pressure on departmental ceilings.
Improving the composition of spending will require renewed efforts by government to manage the public-service wage bill. 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 in 2017/18. Departments will need to continue paying careful attention to managing headcount levels.
The 2018 Budget mentions that government is working to ensure that the current wage negotiations process results in a fair and sustainable agreement.
R57 million budgeted for free higher education and training
Over the next three years, more than half of government spending will be allocated to basic education, community development, health and social protection.
Funding for fee-free higher education and training will amount to additional spending of R57 billion over the medium term.
There is a provisional allocation in 2018/19 of R6 billion for drought management, assistance to the water sector, and to improve the planning and execution of national priority infrastructure projects.
The burden of state owned enterprises (SOEs) on the South African economy
The Budget recognises that the financial risks posed by the broader public sector remain significant. The Budget Review makes it clear that any additional commitment of public resources to state-owned companies will be associated with far-reaching governance and operational interventions – including, where appropriate, private-sector participation.
The following steps have already been implemented:
• A new board and acting chief executive officer have been appointed at Eskom.
• The Minister of Energy has instructed Eskom to conclude all power-purchase agreements with independent power producers.
• Government has granted South African Airways R10 billion to settle its short-term debt obligations. A new board, chief executive officer and restructuring officer have been appointed. A turnaround strategy is being implemented.
• Cabinet has approved a private-sector participation framework for state-owned companies.
• The Competition Commission’s market inquiry to investigate data prices will be complete by end-August 2018.
• Draft legislation is being prepared to allow Postbank to apply for a banking licence. The National Treasury and the Department of Telecommunications and Postal Services have met the Banking Registrar to discuss a Postbank structure.
Main tax proposals for 2018/19
• A one percentage point increase in VAT to 15%.
• No adjustments to the top four income tax brackets, and below inflation adjustments to the bottom three brackets.
• An increase of 52c/litre for fuel, consisting of a 22c/litre increase in the general fuel levy and 30c/litre increase in the Road Accident Fund levy.
• Higher ad valorem excise duties for luxury goods.
• Increased estate duty, to be levied at 25% for estates above R30 million.
• Increases in the plastic bag levy, the motor vehicle emissions tax and the levy on incandescent light bulbs to promote eco-friendly choices.
Glimmer of hope?
The 2018 Budget is introduced as government has an opportunity to reinforce confidence and contribute to a recovery in growth and investment. A renewed sense of optimism is driven by the expectation that government will finalise many outstanding policy reforms, act decisively against corruption, and swiftly resolve governance and operational failures at state-owned companies. Investor sentiment has improved, leading to a strengthening rand exchange rate and lower government borrowing costs.
The rand strengthened significantly against the US dollar during 2017 and the first part of 2018, reaching R11.64/US$ today – a level last seen in 2014. The currency’s recent performance reflects investors’ reaction to domestic political developments, as well as overall strength in developing-country currencies. These currencies benefited from US dollar weakness, the search for higher yields by international investors and rising global commodity prices.
Recent events suggest an upturn in the business cycle. Statistics South Africa’s December 2017 economic statistics revealed an unexpected improvement in the economic outlook, largely as a result of growth in agriculture and mining. The SACCI business confidence index reached its highest level since October 2015 – and the Absa purchasing managers’ index its highest level since January 2010.
South Africa’s potentially stable macroeconomic environment provides a strong platform to attract much-needed foreign savings that can fund additional investment. The country’s prudent macroeconomic policies are highly regarded by international investors, as are its well-developed and well-regulated financial markets. If Budget 2018 stands as a commitment by government to practice sustained fiscal discipline, this could certainly steer South Africa’s economic fortunes in the right direction. We’re well advised to keep watching this space.
Published in: Cape Argus 22 February 2018