Budget preview – Gordhan on a tightrope

Since the September Mini Budget, Government revenue has disappointed. All of the big ticket items are going to fall short of the Treasury’s mid-term projections. Although in part a consequence of the post Wold Cup soft patch that the economy experienced in the latter part of the year, it is also the result of regulatory changes in the payment schedules for corporate tax. As a consequence of the revenue shortfall, the deficit for the year will be a little wider than expected at 5.5% of GDP. However, this should not affect bond issuance for the year, as the slack will be made up from short-term borrowing and cash balances. The bond market will therefore turn a blind eye to the marginal deterioration in the deficit.

Little room for tax relief

More worrying is that this may not be a good base from which to start the new financial year. It will be a challenge for Finance Minister Pravin Gordhan to achieve the R745 billion revenue target for the new year he announced during the Mini Budget. In respect of personal income tax, he will find it difficult to make the essential inflationary adjustments to the various brackets and it is therefore unlikely that he will be able to provide any real personal income tax relief.

The target for company tax will have to be quite demanding, something in the order of 20%, given that the growth for the current year has been somewhat disappointing and the base is therefore low. This target is however not impossible if one takes into account the earnings increases in the region of 30% we are currently seeing on the JSE.

VAT started the current financial year with a bang but is ending with a whimper. Here as well, the Minister will feel a little bit uneasy about achieving the 10% or so VAT revenue increase that will be required to meet the overall government revenue target.

In this environment, one of the unknowns is whether the Minister will have enough room to implement the long-awaited switch from STC to withholding tax on dividends. There will also be pressure on him to be somewhat aggressive in terms of the usual sin tax increases.

A tighter deficit target?

In the September Mini Budget, the Minister made it clear that he would aim for a deficit of 5% of GDP for the coming year. The big question is whether Gordhan is going to surprise us by all by trying to run a tighter ship than expected in the coming year. The President also recently affirmed that the medium-term objective is to bring the deficit down to between 3% and 4%. One of the principles of the New Growth Path is that Government finances should be somewhat tighter so as to enable the monetary authorities to keep rates lower than would otherwise have been the case and to create room to weaken the currency. My guess is that he is indeed going to signal a somewhat faster reduction in the deficit than expected and maybe aim for something like 4.5% or slightly above.

A slightly smaller deficit would be welcome news to the bond market as it would enable the Treasury to cut back on the current level of issuance, but this is about the only constituency that would be happy.

The main challenge to a tighter deficit is expenditure. To cut the deficit by 0.5% of GDP, for example, Government’s expenditure target would have to be trimmed by about R10 billion. This may be a step too far in the coming, so he will probably end up with a deficit that is slightly lower than expected, but certainly not that aggressive either.

The big unknowns

The biggest interest on the expenditure side will be whether the Minister will signal that he is ready to provide funding for the National Health Insurance. The President has recently promised that a policy document would be made public soon. Everyone will be watching to see how much that might cost.

The authorities took a bold step in December when they raised the foreign allowance for institutions from 20% to 25%. There is a reasonable expectation that that might have been an interim step and that we will see a further adjustment to 30% in the budget. That would bring institutional investments in line with retail investments and is very much part of Government’s approach towards weakening the currency.