Budget ‘most critical’ one since SA’s 1994 transition to democracy

By Janice Roberts
Editor

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Finance Minister Pravin Gordhan has promised to take the necessary steps to avoid a credit rating downgrade when he tables the 2016/17 Budget on Wednesday. Enormous damage was caused by December’s “Nene-Gate” and the threat of a rating downgrade to junk status – notably from Fitch and S&P – is looming.

“We think this Budget should be judged through a ratings and therefore long-run growth lens to see whether real reform is forthcoming,” says Peter Attard Montalto, Senior Emerging Markets Economist and Strategist, Nomura International.“Our broad view is that fiscal conservatism will be delivered on, but with so little fat left on the bone to be cut in future years that this will be the end of the road. However, the market may well view this kind of budget as a positive, meeting expectations on fiscal policy and possibly ignoring any missed expectations on growth-related policies.

“In other words, spin may win the day at least in the short run, though we think rating agency commentary after the event will be particularly important for the market.”

Expectations of softer global economic activity and broad-based downward revisions to South Africa’s growth outlook (by the Reserve Bank and IMF among others) will cause the Treasury to lower its own GDP expectations, says Annabel Bishop, Investec Bank Limited’s Chief Economist in South Africa.

“In the MTBPS, the Treasury projected growth of 1.7% for 2016 and 2.5% for 2017. Treasury is now likely to adjust their forecasts lower, towards the 1.0% mark in 2016 and 1.5% mark in 2017, closer to those of the IMF and World Bank.”

In this Budget, Treasury will have to show constraint when it comes to spending.

“We think the main strategy for cuts will be a continuation of the tactics we described last year, whereby many small cuts will be made deep within departmental budgets,” says Attard Montalto.“Some headlines however may include an increased focus on procurement efficiency and things such as travel and conference expenses. However, these areas have already been cut substantially, such that we see little additional scope for meaningful cuts and instead it will be used for optics.

“We do not see it being politically possible in this current political climate, and in an election year to alter a multi-year wage agreement and reduce public sector wage growth that has already been promised. Nor do we think meaningful personnel reductions are possible after the previously announced removal of vacancies etc.

“We do not think a cut to public sector works programmes is possible (it is a very politically sensitive topic – and a programme which is basically a form of unemployment insurance). This currently will make up around ZAR12.5bn of spending in the coming fiscal year. However, some savings in terms of slowing its future growth in outer fiscal years might be possible to save ZAR1-2bn.”

He adds that a lot of cuts may be buried in unspecified austerity, pushed down into the provinces and local government that have expenditure of respectively around ZAR503bn and ZAR106.9bn projected at the MTBPS for the coming fiscal year.

“That is they make up over half of all expenditure, albeit partly allocated through departments. We think the provinces will be allowed to have a greater say, and take the political can for austerity decisions.

“Overall, we look for around ZAR30bn, ZAR40bn and ZAR75bn of expenditure cuts beneath the surface in the coming fiscal years from 2016/17, respectively, once other possible revenue and expenditure increase items are accounted for. This would represent 0.7% of GDP in the coming fiscal year.”

Nedbank economists say the revenue for the next three years will be determined by Treasury’s projections on economic growth and inflation, as well as changes to tax policy based on the recommendations of the Davis Tax Commission.

“In the State of the Nation Address, the president suggested that government will step up the scale of non-strategic state-owned enterprises, which could also boost revenue over the next three years.  However, it is not at all clear that there is appetite for these entities in the private sector,” they add.

Attard Montalto expects there to be a wide range of smaller changes that add up to a targeting of broad-based revenue increases across the tax base to minimise the impact on growth.“We think a 1-2pp VAT hike is possible to 15-16%, which would raise around ZAR15-30bn. Previously, this was politically impossible before the NHI started to be more fully rolled out, especially before the local elections.

“However, we think with the publication of the white paper on the NHI at the end of last year, it is now possible politically to bring forward VAT hikes to before the election.”

He also sees shifts to personal income tax changes raising around ZAR3.0-4.5bn in the coming fiscal years.

“We think there will be slow bracket creep, meaning tax brackets increasing by less than inflation to sweep in more people. In addition, we expect either a new super-income tax rate or a slightly higher current tax rate for the top band to appear progressive, though we think the fiscal impact of this alone is small.

“We think an increase in dividend taxes is possible, but wider corporate tax increases are less likely.”

He doesn’t expect a wealth tax.

“First, this is logically very challenging to implement fast. Second, the National Treasury has said that it won’t act before the Davis Tax Commission rules on it which is unlikely until later this year because it only received the brief towards the end of last year.

“Finally, we think the National Treasury is fundamentally against the idea. We think it will only be referenced as being studied.”

Bishop warns that failure to show measures which will actually boost economic growth and markedly curtail current government expenditure (particularly spend on civil servants’ remuneration) will likely prove insufficient to avoid a downgrade to sub investment rating at a point over the next three years.

Indeed, whatever this Budget advocates, credit rating agency worries over growth will persist.

Nedbank economists put it well when they point out: “This year’s Budget is arguably the most critical from both an economic and a political perspective since South Africa’s transition to democracy in 1994.”

We don’t have long to wait now until Budget 2016/17 is tabled.  We can only hope it will restore some confidence in our ailing economy.

 

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