2014 National Budget: fiscal consolidation could be further delayed

 

Although Treasury revised their growth outlook lower in October last year to reflect a more credible outlook, we have, since then, factored in further downside risks to GDP growth for both this year and the next. As a result thereof, Treasury’s 3.0% real growth expectation for SA in 2014 looks relatively robust in comparison to the South African Reserve Bank’s (SARB) 2.8% and our in-house forecast of 2.5%. Similarly, we believe there is scope to scale back their 2015 GDP forecast of 3.2% to 2.9% on our growth assumptions.

 

Since the time of the Medium Term Budget Policy Statement (MTBPS), the rand has depreciated by c.10% against the US dollar and by c.9% on a trade-weighted basis. Given the anticipated currency pass-through effect, notwithstanding a weaker growth environment, we expect Treasury to upwardly revise their inflation forecasts of 5.6% (2014) and 5.4% (2015), but not to the same extent as the SARB’s hawkish view of 6.3% (2014) and 6.0% (2015).

Furthermore, Treasury revealed a rather sticky current account deficit projection in October last year, which, in our view, could be scaled back on the prospect of soft domestic demand conditions and a potential uptick in export volume growth as global growth conditions improve towards the latter half of the year.

 

Despite the deceleration in economic growth momentum, we suspect that National Treasury likely comfortably achieved their revised budget deficit target of 4.2% of GDP for FY13/14, as was set out in the MTBPS released in October last year, due to a possible revenue overrun. Extrapolating the performance of government revenues for the first nine months of FY13/14, revenue growth at 11.6% year-on-year currently outstrips the revised MTBPS assumption of 10.0% year-on-year, suggesting that the potential revenue overshoot could amount to between R9 billion and R12 billion. Despite the weaker economy and disruptive labour unrest, personal and company income tax performed reasonably well up until December 2013, while the performance of VAT intake disappointed Treasury’s revised expectations, in line with our view of rising headwinds to consumer spend. While the effect of strike action and tight electricity supply pose a risk to the momentum in corporate tax uptake, stock-piling in the platinum mining industry and the timing of financial year-ends and provisional tax payments may provide a partial offset in this regard.

 

On the back of further downside risks to Treasury’s growth outlook, we could potentially be facing yet another delay in medium-term fiscal consolidation. Over the past few budgets, Treasury has consistently pushed out the expected date at which SA’s budget balance reaches a more palatable 3.0% of GDP, allowing for debt stabilisation and the creation of more fiscal space. We suspect that there could be downside risks to Treasury’s estimate on personal taxes and VAT intake based on lower nominal GDP forecasts, while Treasury’s assumptions on corporate tax collections appear conservative relative to the consensus on corporate earnings expectations.

 

After cutting expenditure by around R20 billion over the fiscal years FY12/13 to FY14/15, government further imposed a non-interest (real) expenditure ceiling of 2.2% over the projected horizon, which is significantly lower than the 9.4% average since FY03/04 (inflated by a bloated government wage bill and onerous social grant disbursements). In our view, there could be moderate upside risks to the wage bill this year given Treasury’s MTBPS implied forecast of c.9%, relative to the 10.5% average over the past four years, after adjusting for the number of employees, allowances and pay progressions at different levels of government. The current wage agreement with civil service unions expires around the middle of this year when government’s ability to align wage increases to inflation (allowing for a marginal buffer and pay progression) will be tested yet again. On a more encouraging note, it appears as though government has enforced a tighter hiring discipline, given the deceleration in the growth rate of government employees recently observed in Stats SA’s Quarterly Labour Force Survey.

 

Moreover, a higher funding requirement, coupled with a rising rates trajectory, places further upside risks to government’s interest bill, which is already the third-fastest growing expenditure item in the budget and currently projected to increase at an average rate of 11.5%.

With the composition of government’s spending triggering concerns in the past, we remain short-term bearish on local government capital expenditure given capacity constraints and corruption. We look forward to an update from the Office of the Chief Procurement Officer, which was created in April 2013 to minimise wasteful expenditure and corruption.

We see the potential for some allowance for bracket creep at the middle to lower-end of the consumer market, while our estimated downside risks to personal taxes could be countered by a potential increase in tax rates for higher-income earners or, possibly, a rise in the VAT rate. However, we see this as being more of a risk next year, given that this is an election year and the unexpected earlier tightening of monetary policy will impact the upper-end consumer the most. The outcome of the Tax Review Commission, which was established early in 2013, is unlikely to be ready by the February Budget, further reinforcing our view for income taxes to remain largely unchanged over the coming fiscal year.

While rising inequality and elevated levels of poverty dispute the need for a VAT increase, government’s earlier suggestion that a combination of VAT and payroll tax hikes could be used in funding the National Health Insurance (NHI) implies that VAT hikes cannot be ruled out. The previous tax commission has argued, however, that, while zero-rated products and exemptions must be considered, streamlining tax administration is important. As a result, multiple VAT rates on different types of consumer goods seem a less likely option.

We may receive further updates regarding the implementation of carbon taxes, which is currently set for January 2015, as well as an update on the Mining Taxation Review.

Despite a R9.5 billion downward revision to the borrowing requirement in the October MTBPS for FY13/14, there was a sizeable R48.4 billion upward increase between FY14/15 and FY15/16. Should revenues disappoint, particularly in the latter years of the medium-term expenditure framework, relative to Treasury’s forecasts, there could be further pressure on domestic long-term issuance, in our view.

Considering the two-notch gap between SA’s current local and international rating, we could see a downgrade in the form of a one-notch cut to SA’s local debt rating. SA’s ability to reduce the budget deficit substantially, to level off the public debt to GDP trajectory, will remain key to SA maintaining its sovereign debt rating. In October, Treasury highlighted the need for expenditure restraint beyond the medium term and alluded to the possibility of revenue adjustments in order to create more fiscal space and curb public debt to GDP, which Treasury expects to peak at 44% in FY17/18.

 

While the ratings agencies maintained their respective outlooks on SA’s sovereign rating recently, tax changes are becoming increasingly likely against sizable downside risks to Treasury’s growth and revenue projections. Furthermore, government’s ability to stick to its expenditure ceiling and maintain a favourable spending composition remains firmly in the spotlight.