Investment Solutions: Lesiba Mothata comments on #MTBPS2016

Lesiba Mothata, chief economist at Investment Solutions.

Finance Minister Pravin Gordhan has confirmed that South Africa remains on a prudent fiscal management path. Prior to the medium-term budget policy statement (MTBPS), there was much angst about whether material changes would be noticeable – changes to what has been the norm over the past two decades of policy formulation. The MTBPS remains consistent with what was largely expected: weaker gross domestic product (GDP) growth, declining tax revenue, consolidated fiscal expenditure and firmly-controlled debt balances.

Education

The #FeesMustFall campaign has received particular attention from the finance minister. Expenditure on post-school education has increased substantially, becoming the second fastest growing component of expenditure at 9.2% over the next three years. Financing costs on debt are rising fastest, at 10.1%, due to rand depreciation and the increasing stock of debt.

An additional R17 billion has been set aside for universities and students, with a notable increase in National Student Financial Aid Scheme (NSFAS) allocations, which will be growing 18.5% in the next three years.

Wage bill

The number of national and provincial employees has plateaued at around 1.25 million. Since 2012, there has been no noticeable increase in head count. Wage growth, however, remains firmly above the upper 6% inflation target range. According to data from the South African Reserve Bank (SARB), between 2010 and 2015, unit labour cost growth averaged 7.0% and is forecast to accelerate to almost 8% in 2016. Pre-agreed public sector wage deals, which run for multiple years, is the main contributor to this outcome.

State-owned enterprises and guarantees

The National Treasury has recognised that guarantees set aside for state-owned enterprises (SOEs) are a potential source of vulnerability. As it is, the state has committed R467 billion (about $34.0 billion) in guarantees for SOEs. The lion’s share of this is earmarked for Eskom. Recently, the power utility has received a $500 million loan - with a potential of an additional $4.5 billion from the China Development Bank. While the loan will go a long way to funding Eskom’s capital expenditure plans, the implicit guarantees behind the loan will attract attention from investors as contingent liabilities, in the event of default, could become real liabilities.

It was not clear in this MTBPS whether there would be additional guarantees to this end, as this could have negative consequences on debt accumulation.

Debt consolidation

Due to rand depreciation and weak GDP growth, debt remains elevated. For every one rand earned by the National Treasury, a substantial amount is used to pay interest costs. It was encouraging to see that the medium-term expectation for the net debt to GDP ratio will taper off around 49%. GDP growth sustained at higher levels, say 3%, is one of the most potent ways to deal with escalating debt levels.

Fiscal risks

Most of the forecasts displayed in the MTBPS are hinged on economic growth anticipated to rise towards 2.0% in the next three years. Although South Africa enjoys a global tailwind from improved Chinese GDP outcomes and relatively stronger export growth, the metrics on fiscal policy can change drastically should these positive forces dissipate.

Taxes

Tax pronouncements are usually made in the main February budget announcement, which in February 2016 introduced capital gains tax, transfer duties on high-end real estate and taxes on sugary beverages. This was deemed a “tax-light” outcome. It remains to be seen whether additional taxes will be introduced. There is a chance a higher income tax bracket - or even a direct wealth tax - will be introduced next year.

With such weak domestic economic activity, tax hikes are likely to prove corrosive to growth. In the words of David Ricardo, one of the founding fathers of economics: “there are no taxes which have not a tendency to lessen the power to accumulate”. During the past five years, South Africa’s household savings ratio contracted to more than one percentage of disposable income, reflecting inter alia the disincentive of higher taxes. Increasing taxes is not a solution to South Africa’s weak growth.

Bottom line

There is little in this MTBPS that will cause ratings agencies to recommend severe downgrades of South Africa’s credit.