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Papering over the cracks

21 February 2019 Citadel

But will it be enough to satisfy the rating agencies?

This was always going to be one of South Africa’s toughest budgets with enormous pressure on government resources in an extremely difficult economic environment. Under the circumstances, relatively new Finance Minister Tito Mboweni can be praised for his disarming honesty and openness about the vast challenges that Treasury faces. Unfortunately, however, this cannot make up for the constraints currently being confronted.

Perhaps the biggest surprise was – with less than three months to the general election – a budget that was certainly not populist.

Papering over the cracks

“While the minister papered over the cracks, the reality of a debt-to-GDP ratio that increases to 60.2% and a deficit that is higher at 4.5% of GDP leaves us in no doubt that the budget is credit negative and South Africa’s fiscal metrics have all deteriorated again,” observes George Herman, Citadel Director and CIO.

“While it’s positive that we will not be taking any Eskom debt onto the government balance sheet, we will be providing R69 billion to the utility over the next three years. Taken together with a R122 billion increase in government guarantees over the same period, it means a R191 billion step backwards over the next three years. And this is without even considering entities such as the Road Accident Fund, which has a R215 billion hole to fill.”

The support for Eskom initially frustrated the markets, with the rand and bonds dipping on the news. However, as the speech progressed, they clawed back their losses and were trading close to earlier levels.

“I believe that the minister’s firm approach to Eskom’s debt and his mention of finding a strategic private partner for the transmission component once the utility has been broken into three elements can be viewed as positive from an economic point of view,” states Maarten Ackerman, Citadel Chief Economist and Advisory Partner.

You’re going to pay more tax ...

Although the tax rates for personal income tax were not raised, the tax brackets remain unchanged. “This, combined with a thrust to improve tax collection, means that bracket creep will deliver some R12.8 billion more in terms of personal income tax,” notes Herman. “It’s a stealthy way to raise revenue without creating a tax revolt.”

There were the usual hikes to sin taxes which are expected to yield an additional R1 billion, and the carbon tax to be implemented on 1 June 2019 together with increases in fuel taxes will raise a further R1.3 billion.

... and there’ll be no place to hide

The minister was clear that tax evasion would continue to be an area of focus and tax collection a priority. SARS is improving its IT systems and integrating them internationally. Information sharing agreements are helping to fight cross-border tax evasion schemes and linking between different entities, both locally and globally, will mean that taxpayers have nowhere to hide.

“Taxpayers will need to structure their finances in a more transparent way,” notes Theunis Ehlers, Citadel Fiduciary Propriety Limited Director. “Compliance for businesses and individuals will be critical and all are advised to have their tax affairs in order.”

On the topic of tax, Ehlers noted that a wealth tax was conspicuous by its absence from the budget. “I was surprised not to see mention of such a tax in an election year. This is an area where the government could have gathered some additional income without impacting too negatively on the ANC’s electoral base.”

While government aims to trim its spending

It’s very clear that the government wage bill and size of public sector is a major problem that needs to be addressed. “It is proactive to look at this in an election year, but the hope is to reduce it through “natural” attrition by encouraging government employees aged 55 to 59 to gracefully retire,” notes Ackerman.

“Of course, this isn’t an active measure – it’s simply hoping that the wage bill will be reduced by this method. There will be no increases for parliamentarians and executives at SOEs, which is positive, although the absolute number remains large.”

In total, the target reduction in government spending is R50 billion over three years with 50% of this coming from reduction in the public sector wage bill.

On the positive side, R100 billion is being assigned to an infrastructure fund in order to support economic growth. But the spend will be over a 10-year period, so its impact will be slow and modest.

“Encouragingly, after a decade of mismanagement and corruption in State-Owned Enterprises, government will make use of the private sector in design and build,” says Ackerman. “This is really what we need, because if government provides the framework and funding, the private sector can create jobs. This will, in turn, create opportunity for government to reduce the public sector wage bill over time.”

However, in the near term, with individuals paying more in tax and the government curbing its spending, this budget is not supportive of economic growth.

But will it satisfy the rating agencies?

“A fiscal deficit of 4.5% and a debt-to-GDP ratio of 60.2% is really pushing the limits,” says Ackerman. “Both of these numbers are in the red zone as far as the ratings agencies are concerned, and if we make one misstep, we would be very close to a downgrade.”

“The GDP numbers are obviously crucial and I think the 1.5% forecast for this year is realistic, increasing to 1.7% next year and then to 2.1% the following year.

“Keeping Eskom’s debt off the balance sheet is positive and the rating agencies are likely to give us the benefit of the doubt for now, but time will tell if we can implement the policies that we have put on the table.

“Should economic growth not materialize, then those deficit and debt numbers could be much weaker than budgeted for at the beginning of the period. So I do think there is a risk that rating agencies are not going to like this.”

“For now, I think Mboweni might have bought us a little more time.”



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