Budget 2020 - Navigating a challenging path to a sustainable fiscal position

The challenges facing the South African (SA) economy are well documented, and perhaps larger than any faced in the post-democratic history of the country.

Over the last 5 years SA has experienced one of the weakest average growth rates in per capita gross domestic product (GDP) from a range of emerging economies. This leaves treasury with the challenge to increase revenue, as well as cut spending, in order to put the country on a path of fiscal sustainability.

According to Momentum Investments economist Sanisha Packirisamy, increasing revenue will be tough as business and consumer conditions provide a tricky setting in which to raise additional taxes.

“SA’s relatively high corporate income tax rate (28% in SA compared to a global average of 24.2%) and government’s desire to draw foreign direct investment towards the country suggest little scope to raise corporate income rates further. Similarly, an increase in personal income tax, SA’s largest source of revenue, would be difficult to implement in light of persistent consumer headwinds, including higher electricity tariffs, higher fuel prices, slower growth in nominal wages and rising unemployment.”

Raising the VAT rate will also be a challenge. Even though SA’s VAT rate is comparatively low on a global scale, an increase now would come at a time when growth in household spending has fallen below 1%, compared to 2.8% when the VAT rate was increased in April 2018.”

“Advancing capacity at the SA Revenue Service (Sars) to collect taxes, a decrease in tax evasion and fraud and a restoration in tax morality provide potential to alleviate pressure on revenue collection in the coming years,” Packirisamy continues.

She points out that subdued economic growth is unlikely to provide a boost in revenue prospects in the foreseeable future. “The weak momentum in the SA economy ultimately reflects chronic policy uncertainty, stretched government finances, infrastructure constraints and crushed confidence.”

These factors will translate into a revenue collection shortfall versus the medium-term budget of around R14 billion for FY2019/20 if VAT refunds normalise according to Packirisamy. Persistent tax revenue shortfalls in the last few years have materialised in spite of the implementation of additional tax hikes, including the 1% VAT increase and an increase in taxes for the top personal income tax bracket in recent years.

Cutting expenses might be arguably a bigger challenge than raising revenue in the current political environment. A bloated government wage bill and burdensome debt-service costs are crowding out other forms of more useful government expenditure. For every R1 000 spent on consolidated expenditure, R340 is currently paid to civil servants.

“Expenditure cuts have to come from the wage bill,” Packirisamy notes. “While an across-the-board wage freeze for civil servants is less likely, government could potentially achieve a significant portion of its intended savings of R150 billion, as announced in the Medium Term Budget Policy Statement in October 2019, through earmarking higher-income categories for wage freezes and bonus cuts, while implementing strict inflation-linked increases for the remainder. Whether there is the political will do this remains to be seen.”

Packirisamy further points out that a major concern is the ballooning government debt. “Over the last decade SA has consistently spent more than what we have earned and this shortfall has been funded by debt. This has resulted in debt-servicing costs growing at an average of 13.5% per year for the past eight years, making it our fastest growing area of spending. Currently, of every R1 000 spent by government, R115 is used to service government’s interest bill. Treasury has warned that without further fiscal measures, spending on debt-service costs will outpace spending in areas such as health and community development by FY2022/23.”

This balancing act will be closely watched by Moody’s, the last rating agency which has SA on an investment grade rating.

“The fact is that the depth of SA’s social and economic ills requires urgent and decisive action. With growth and fiscal outcomes continuing to surprise to the downside, we expect additional downgrades by both Moody’s and Standard & Poor’s Global Ratings (S&P) this year.

Recent comments from Moody’s that its 1 November 2019 rating was still “relatively fresh” and that there was “nothing really to flag for the time being” may suggest that, in the absence of a large negative shock in the budget on 26 February 2020, the rating agency may decide to leave its rating unchanged on 27 March 2020 and defer ratings action to 20 November 2020. In our view, the risk of a Moody’s downgrade of SA’s sovereign rating from Baa3 (the last rung of investment grade) to Ba1 remains high in 2020.” Packirisamy concludes.

MOMENTUM INVESTMENTS BUDGET OUTLOOK - Potential additional revenue measures and increases in existing taxes