Taxpayers can still expect some budget relief: OMIGSA

Despite this year’s unexpectedly large budget deficit, lower income earners can likely still look forward to some tax relief in the government’s 2010-11 Budget, to be unveiled by Finance Minister Pravin Gordhan o­n 17 February, according to Johann Els, senior economist at Old Mutual Investment Group SA (OMIGSA).

Els says that likely increases in excise duties, the fuel levy, and possibly electricity tax and capital gains tax, plus positive revisions to original estimates for GDP growth, consumer spending and inflation, should give Gordhan room to make moderate upward adjustments to tax brackets for lower income earners to compensate for inflationary “bracket creep”. High income earners, however, may not be so lucky.

“This year it’s a real balancing act for National Treasury between the priorities of reducing the deficit and not choking off the economic recovery,” explains Els. “Because of the large 2009-10 budget deficit (we expect around 7.8% of GDP), there’s very little chance of unexpectedly big tax relief o­n the scale we saw last year (R13.6bn), but there’s still a strong possibility of some help for those in the lower income brackets. By contrast, there’s an outside chance Gordhan could unveil a temporary rise in the top marginal tax rate for individuals.”

Given the importance of deficit reduction, Els also believes the National Treasury could possibly surprise the markets with plans for an even lower 2010-11 deficit than the -6.4% of GDP forecast in the October 2009 Medium Term Expenditure Framework (MTEF). “The bond market would certainly like a lower-than-expected deficit forecast,” he notes. This more aggressive deficit reduction is possible due to expected higher economic growth this year of around 3%, plus the lower growth in spending already built into the MTEF. Budget expenditure growth is set to decline from above 15% in the past two years to under 10% for 2010-11 and the out-years.

Apart from this, Els does not expect changes to company taxes or VAT. Such announcements, along with big individual tax cuts or big exchange control relaxation, would be big surprises, he says. “The reality is that, despite a terrible 2009-10 in which actual revenues are going to fall short of the original February 2009 estimate by a huge amount (we estimate around R75bn), thanks to previous years of budget surpluses and a relatively conservative fiscal policy, South Africa isn’t in bad shape relative to many developed economies coming out of the global recession,” observes Els.”Our actual debt levels and servicing requirements are lower than most, our growth rate is projected to be better than most, and although the deficit is big, our ability to reduce it over coming years is unquestionable. This has meant that the National Treasury still actually has room to manoeuvre.”

Budget implications for SA bond and interest rate markets
According to Wikus Furstenberg, senior portfolio manager at specialist fixed interest asset managers Futuregrowth, the most important budget numbers for the local bond and interest rate markets will be the funding mix between short-term and longer-term debt, and its impact o­n the local yield curve.

“In fact, the interest rate market will be focusing o­n the funding mix, to see if the National Treasury will indeed be sticking to its stated intention in the October 2009 Medium-Term Budget Policy Statement (MTBPS) to rely far less o­n short-term debt funding (Treasury Bill issuance), shifting back to more issuance of domestic long-term bonds instead,” explains Furstenberg.

“We at Futuregrowth believe the 2010 Budget is more than likely to confirm this shift back to long-term funding. This is mainly for two reasons.

"First, National Treasury’s large issuance of Treasury Bills in the past financial year has run the risk of further “crowding out” private sector borrowers in the money market (where instruments with a term to maturity shorter than twelve months are issued). In the 2009-10 financial year there has been exceptionally high government borrowing (about R50bn in gross Treasury Bill issuance compared to about R10bn to R15bn in recent years) as an interim measure in the aftermath of the global credit crisis and the sudden and unexpected worsening of state finances.

"Second, a greater reliance o­n long-term domestic bond issuance would re-align funding with National Treasury’s long-held internal risk management strategy that is weighted toward domestic long-term funding.”

Continuing high long-dated bond supply puts yields under upward pressure (in the absence of falling inflation)
Importantly, says Furstenberg, as a result of this strategy they expect the average weekly issuance of long-dated government bonds to remain elevated despite a lower 2010/11 budget deficit than 2009/10.

The total borrowing requirement of the broader public sector (national government plus non-financial public enterprises) is expected to remain at historically high levels. “This elevated bond supply means that there remains a risk that longer-dated bond yields will move weaker during the year, depending o­n the market’s ability to absorb the extra issuance.

“As the primary driver of bond valuations, generally, an improved inflation outlook will certainly go some way to assist in absorbing some of the new supply in the next few months,” notes Furstenberg.

“However, it is questionable whether the bond market is going to continue to benefit from strong net foreign buying and some allocation by balanced retirement funds to this asset class over a longer period. Therefore, it is more than likely that the yield curve slope will steepen further (with long rates moving higher than short rates), especially in a scenario where the inflation outlook starts worsening by the end of 2010,” he concludes.