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The cost of free everything

11 April 2021 Gareth Stokes

The COVID-19 pandemic will have inter-generational consequences on South Africa’s fiscal position and will affect emerging market economies more than developed markets. Andrew Canter, chief investment officer at Futuregrowth Asset Management, observed that the economic damage caused by the 2020/21 pandemic was equivalent to that caused by World War II, with steep declines in GDP worldwide. “Each country is going to follow its own post-pandemic recovery path,” said Canter, as the asset manager set out to answer the question: Does the recent short-term positive outcome bode well for South Africa’s ailing fiscal position in the long term?

SA debt servicing costs could soar

There are two emerging macroeconomic developments that asset managers and financial advisers will be watching closely. The first is the dramatic improvement in economic performance in the first quarter of 2021; the second is the potential for a resurgence in global inflation. A recovery in global bond yields will have consequences for various asset classes, most notably those parts of offshore equity markets that have outperformed on the back of technology. It is too early to predict the impact of these developments on the domestic market other than saying higher interest rates are no good for debt servicing costs. Canter invited Yunus January, an interest rate analyst at Futuregrowth, to share his views on South Africa’s fiscal outlook and the consequence for local bond markets, among other topics. 

January addressed various issues starting with the degradation of South Africa’s tax revenue base before considering whether or not the country was already in a debt trap. “Our three major streams of revenue, being corporate income tax, personal income tax and VAT, have been declining over the last year or so,” said January, before adding that the R100 billion tax collection outperformance between the September 2020 forecast and the February 2020 National Budget should be considered a once-off. This improvement in revenue collection came on the back of better than expected corporate income, mainly in the mining sector, and VAT collections surprising to the upside. The picture is not as rosy in the personal income tax space. 

The dwindling group of high margin taxpayers

“We see a worrying decline in the number of assessed taxpayers going back to 2012; although more individuals are registered for tax, there are fewer paying it,” said January. Another cause for alarm is that 10% of taxpayers, or 1% of the country’s population, are chipping in 54% of personal income tax. South Africa is now in a similar position to countries like Germany and the United States, where there is an overreliance on top tier taxpayers. There is both good and bad news for taxpayers going forward. National Treasury has allocated another R3 billion to the South African Revenue Services (SARS) to bolster its audit and investigative functions. “SARS has identified an amount of R12 billion which could be recouped [by a clampdown on] non-compliance with VAT and income tax regulation,” said Refilwe Rakale, Research Analyst at Futuregrowth. 

It does not matter how efficiently taxes are administered and collected if government is unable to rein in fiscal expenditure. Years of ‘kid gloves’ treatment of public sector employees has created a ticking time bomb that sees wages in this segment outstripping inflation by miles. “The wage bill has increased six-fold over the past decade while inflation has increased just 2.8 times,” said January. Of greater concern is that three quarters of this surplus was driven by wage growth and just one quarter by increasing the labour force. South Africa now boasts a public wage to GDP ratio of 14.8% compared to the global average of 10.2%. Against this backdrop, National Treasury has no option but to freeze public sector wages. 

Free everything costs billions

“We welcome government’s commitment to cutting expenditure; but must concede that the execution of such cuts has not been great,” said Rakale. It is also likely that cuts in public sector wages will be offset by other social imperatives such as free higher education, National Health Insurance (NHI) and possibly a basic income grant. “We see increasing pressure from higher education with an additional allocation of R5 billion in 2020/21; the cost of writing off all student debt coming in at around R14 billion and the cost of free education being a staggering R100 billion per three-year cycle,” she said. A free education system could add two percentage points to South Africa’s debt-to-GDP ratio. 

An understanding of the structure of South African debt is important in considering whether or not the country is in a fiscal debt trap. According to January, government benefits from issuing a high proportion of debt in domestic currency; but cautions that as much as 30% of this debt is held by foreign investors. “Although we have a low level of foreign currency debt, it does not mean we are not exposed to foreign investor sentiment,” he said. Another concern is that government contingencies and provisions for State-owned Enterprises (SOE) debt has almost tripled since the Global Financial Crisis in 2008/9. Futuregrowth said that a debt default was unlikely and pointed out that government had adequate time to either renegotiate or raise new capital to pay off the large debt redemptions occurring in the coming years. 

Above-trend GDP growth is a must

Consistent above-trend GDP growth was again singled out as the only way to improve the country’s fiscal outlook. “We anticipate an improvement from 2020; but a recovery to 4% this year and 2.5% to 3% over the medium term will not be enough to move from a primary deficit to a primary surplus,” said Rakale. A primary surplus occurs when a country’s revenues outstrip expenditures, excluding interest repayments. Success requires government to implement the various structural reforms to make it easier to do business and restore business confidence. At present, South Africa languishes at 84 out of 190 countries on the World Bank’s ‘ease of doing business’ measure, compared to an emerging market average of 57. 

“There is a clear relationship between business confidence and fixed capital formation; without expansion in investment we will not see an increase in production capacity and economic growth will remain benign in the near term,” concluded Rakale. To put the dire situation in context, South Africa needs to grow at 3.5% per annum over the next four years to stabilise its debt-to-GDP ratio. And even 4% average growth over the period leaves the country with a debt-to-GDP of 82%. 

Writer’s thoughts:
A fiscal debt trap is described as a situation in which a country has to borrow more money to fund its existing debt obligations. Futuregrowth concluded that South Africa was technically in a debt trap; but could wriggle free by stabilising the debt-to-GDP ratio and achieving a primary surplus. This may require higher taxes to raise more revenue in addition to prudent expense management. What feedback do you get from your clients with regards their SA personal income tax obligations and the shrinking local taxpayer base? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].

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