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Budget may not have done enough to avert a downgrade, but the focus on expenditure cuts rather than tax hikes will lift sentiment

27 February 2020 Old Mutual Investment Group

The 2020/21 Budget shows National Treasury is willing to make hard choices during difficult times. This is according to Johann Els, Old Mutual Investment Group Chief Economist, who says that Minister Mboweni’s statement is likely to lift business sentiment and ease some pain for long-suffering consumers.

While the absence of net tax hikes is good news for consumers, Els cautions that risks remain around the ambitious plans to cut expenditure on the wage bill, as this still needs to be negotiated with unions.

Baseline spending reductions of R261 billion in were announced by Finance Minister Tito Mboweni on Wednesday, with adjustments on the wage bill penned in at about R160 billion over the medium term.

“While the Budget was better than expected and the positives outweigh the negatives, it was probably not good enough for Moody’s, and I expect South Africa’s sovereign rating to be downgraded in March,” says Els.

A “small probability”, however, remains that Moody’s may delay its decision to see how negotiations with unions pan out.

“Despite still huge deficits and no debt stabilisation, the Budget was on balance better than expected, given the emphasis on expenditure reduction and not tax increases. But the large deficit, debt ratio, primary deficit, combined with still weak economic growth and the risks around the wage bill savings – will still lead to a Moody’s downgrade in March,” says Els.

Another risk going forward – and an aspect to feature on the radar of rating agencies – is that any expenditure savings will be “eaten up” by the growing interest rate bill. Els says interest payments will increase on average by 12% a year over the next three years

Equities are expected to react positively to the news that there will be no net tax increases, apart from the usual “sin” taxes, while bonds could respond more negatively to the very large deficit, rising debt ratio and risks associated with achieving the wage bill savings. Old Mutual expects a neutral inflationary effect.

In a surprise move, individual income tax brackets were adjusted by more than inflation (5.2% versus expected 4.4% inflation). This provides for total personal income tax relief of R2 billion, compared with a potential extra R12 billion had there been no tax bracket adjustments.

“From an inflationary perspective, there will likely be minimal impact as the increases in fuel and excise taxes are generally lower than last year. I also maintain that this still a very deflationary environment,” explains Els.

While the Budget deficit is expected to decline over the next three years, it will explode to -6.8% in 2020/21 from -6.5%, which had been expected in October. The deficit is, however, expected to recede a little from there and is seen unchanged at -6.2% in 2021/22 and -5.7% in 2022/23.

“A deficit as high as -6.8% high will, however, clearly be seen as a risk for Moody’s,” says Els.

“While the very large deficits might seem like this is an expansionary budget, that is not true to the full extent these deficits might imply as expenditure excluding wages and interest payments only rise on average by 4.5% a year over the next three years. That is slightly below expected inflation over this period,” he adds.

The envisioned lower corporate tax rate in future is a positive signal as this will encourage investment and help expand production. But Els cautions that this should not come at the expense of removing incentives in areas where have a proven history of working, like in the automotive industry.

It was announced in the Budget that the government intends to restructure the corporate income tax system over the medium term by broadening the base and reducing the rate. Broadening the base will involve minimising tax incentives and introducing new interest deduction and assessed loss limitations.

South Africa’s corporate income tax rate has remained unchanged at 28% for more than a decade.

“In summary, the positives outweigh the negatives in this Budget, but the jury is out on the wage bill,” concludes Els.

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