Mini-budget preview: Fiscal sustainability a challenge against a weaker growth backdrop

Sanisha Packirisamy: Economist at Momentum Asset Management.

Economic conditions, both globally and locally, have deteriorated since National Treasury last published their real GDP growth projections for South Africa of 2.7% in 2014 and 3.2% in 2015.

Fiscal slippage likely given deterioration in growth outlook

Treasury is likely to downgrade real GDP estimates for this year closer to the 1.6% consensus forecast, as polled by Reuters, given subdued global trade activity and destructive labour unrest in the domestic mining and manufacturing sectors. Treasury’s nominal GDP growth projections could further be trimmed for 2015 given the disinflationary impact of the recent retracement in rand oil prices and relatively benign global food prices of late.

Little room to manoeuvre

While Treasury expected the main budget deficit to remain steady at 4.0% of GDP, the deficit could widen marginally over the medium term relative to February’s forecasts, with South Africa unlikely to reach a deficit smaller than 3.0% of GDP by FY16/17. At this stage, revenue projections are tricky to forecast given that December has been a traditionally high-tax intake month, but initial estimates show that higher inflation and a fairly weak exchange rate have supported company tax revenues. The on-going recovery of unpaid taxes for high-net-worth individuals has also benefited personal income taxes on a fiscal year-to-date basis. Meanwhile, VAT and import duties have underperformed on fragile consumption and a slowdown in imports. Furthermore, the seasonal pickup in corporate taxes may prove to be less robust when compared to previous years given the damaging impact of strike activity that took place earlier this year.

We are of the opinion that, although raising the VAT rate (whilst allowing an offset to poorer households), would go a long way in generating sufficient revenues to achieve the existing fiscal consolidation path, VAT hikes are unlikely to be announced at this stage. Likely options that could be hinted at in the upcoming medium-term budget include raising the marginal tax rate for upper-income households or hiking dividend taxes or estate duties, in addition to the usual fuel levies and sin taxes. With nearly half of South Africa’s personal income taxes being funded by a mere c.6% of the tax-paying population, the debate between raising personal income taxes for the wealthier as opposed to hiking VAT rates, which are regressive in nature, remains contentious. It seems unlikely that company taxes would be increased, given that they are already reasonably high on a global comparison basis and this would be counter-productive in generating an attractive investment climate. Carbon taxes, on the other hand, are likely to be introduced in January 2016 and will affect companies on a more indirect basis.

Will government hold the line on wages?

Although government’s commitment to a self-imposed expenditure ceiling has been welcomed by ratings agencies, reprioritisation in expenditure and anti-corruption savings will be imperative to avoid major delays in capex spend in order to maintain spending limits. In addition, we’ve been through an unsettling year for labour relations in South Africa, with the mining and manufacturing sector strikes setting the precedent for civil servants. Given the upcoming expiry of the public sector’s three-year wage deal, negotiated at 7.5% in March next year, all eyes will be on Minister Collins Chabane’s (the new Minister of Public Service and Administration) ability to rein in public sector wages. With Treasury only allowing for a 1.0% to 1.5% above-inflation increase over the medium-term expenditure framework, initial demands of 15%, coupled with a more-than-threefold increase in housing allowances and a one-year deal on wages, could potentially see another lengthy strike in 1Q15 (akin to the 1.3 million public sector worker strike we observed in 2010).

Recapitalisation plan for Eskom

Since Eskom has been unable to generate sufficient revenues to cover the costs of energy supply, the South African government has stepped in and announced that it would provide Eskom with an equity injection that would likely be funded from ‘leveraging non-strategic government assets’, with an additional debt raising by the utility itself. While this initially implies little direct impact on government’s balance sheet, an increased uptake of guarantees provided would see a further increase in government’s overall debt to GDP ratio. A funding plan for other state-owned corporations, including SAA, would exacerbate South Africa’s debt ratios after accounting for provisions and contingent liabilities.

Government’s ability to achieve fiscal sustainability remains key to ratings outlook

At this stage, we do not expect a further ratings downgrade from S&P, which has the sovereign on a BBB- rating (stable outlook). Nevertheless, reduced fiscal space, the need to accelerate structural reform, prolonged economic weakness and the threat of possibly higher public sector wage settlements will maintain pressure on the country’s ratings outlook over the medium term. If government fails to maintain fiscal discipline and commit to reining in the budget shortfall over the medium term, the ratings outlook by Moody’s (two notches above S&P) and Fitch (one notch above S&P and currently on a negative outlook) could, in all probability, be compromised in the near term.