Why the markets didn’t like the budget

By Janice Roberts

Lesiba Mothata, Chief Economist at Investment SolutionsLesiba Mothata, Chief Economist at Investment Solutions explains why the markets didn’t like the budget.

We need to pay attention to market reaction at the moment.  As Mothata, says: “It is not always accurate to look at market reaction to the Budget and infer investor sentiment towards the outcome. The 2016 National Budget is, however, unique and was heavily anticipated”

“South Africa is at a crossroads and needs to demonstrate an ability to ignite growth and avert negative assessments by credit-rating agencies. Given the pent-up optimism in the currency, bonds and equity markets, this time around it is important to take note of market reaction.

Mothata, notes that in the absence of major market-moving data, globally and locally, markets sold off on the Budget details.

“Despite an ongoing global rally in bond markets, especially in an environment where central banks are easing policy and introducing negative interest rates (the latest to do so is the Bank of Japan, and the Fed is mulling such possibilities), local bond yields increased. The JSE’s financial services sector, which is vulnerable to domestic policy constructs given the close interaction between local bond markets and banks, for example, also declined, further extending its weakness. The rand, which rallied closer to R15/$ ahead of the Budget speech, depreciated.”

He adds that given the forward-looking nature of financial markets, some disappointment had built up.

“The National Treasury’s efforts are commendable: the expenditure ceiling has been lowered, fiscal revenues will improve from the tax increases, plans to consolidate the public sector wage bill seem to be yielding some fruit, and intentions to clean up the state-owned enterprise space could be constructive. Importantly, the recurring Budget theme of close cooperation between the National Treasury and business could yield positive results.”

But, as Mothata explains, “The only two aspects missing from the Budget are practical demonstrations of how the envisaged plans to lift SA’s GDP growth are going to be implemented, and debt-load issues.”

Budget 2016 was one in which we needed to hear a lot more of how the country is going to push up its GDP.

“In assessing credit quality, rating agencies place a heavy weighting on a country’s ability to introduce structural reforms aimed at lifting GDP. Recent data from the World Bank shows South Africa’s per capita GDP (growth per head) has declined from 2011’s US$8 000 level to around US$6 500,” says Mothata.

“In its latest assessment of South Africa, the World Bank noted that the recent decline in economic activity has made it even more important to introduce strategies that will potentially lift growth. Instead of needing the 5% growth stated in the National Development Plan (NDP), South Africa’s economy requires a 7% growth rate to materially alter the unemployment situation and the country’s related social needs.

“This is a full two percentage points higher than that envisaged in the NDP. Admittedly, this outcome is indeed a tall order. The Budget tabulated by Finance Minister Pravin Gordhan lacked detail on how growth is to be lifted.

Mothata explains that due to rand depreciation and higher interest rates, debt-servicing costs have become the fastest-growing item of expenditure and income.

“For every rand earned by the state, 12 cents is paid in as interest costs. If global interest rates tighten further and the South African Reserve Bank continues to increase local rates, the growth rate in this item could accelerate. The stock of debt has also increased substantially.

“In the previous Budget, the net debt-to-GDP ratio was forecast to stabilise at around 44% in the next three years, but has been revised up by two percentage points to 46%. The headline (or gross) government debt/GDP ratio, which is closely monitored by investors and rating agencies, has increased to 51% from 49%. The deterioration in nominal GDP (denominator) has contributed to the worsening ratios.”

He adds that while the Treasury remains committed to stabilising debt accumulation, the trajectory is concerning, particularly in an environment where local growth continues to undershoot.

“The portion of debt denominated in foreign currency remains low at 10% of total debt. The Treasury has shown that non-residents now hold 32% of South Africa’s debt, a notable decline from the 36.4% peak in 2013. It appears that foreign investors have sold South African bonds, especially during the latter part of 2015.”

Mothata is also of the opinion that higher taxes hurt growth and are not a solution for the ills of an economy such as South Africa’s.

“Capital gains tax has been effectively increased by three percentage points (from 14% to 16%) for individuals, four percentage points (from 19% to 22%) for companies, and six percentage points for trusts. Given the low savings rate in South Africa, this could discourage investment.”

In the real estate sector, transfer duty from the sale of homes costing more than R10 million has been increased by two percentage points (from 11% to 13%). The fuel levy has also been increased by 30 cents a litre.

In this Budget, two new taxes have been introduced for the first time in South Africa: a tyre levy to finance, among other things, recycling programmes, and a tax on sugar-sweetened beverages.

“Effectively, South Africans will pay a tax on car tyres and beverages such as Coke. Household consumption expenditure is likely to remain weak as consumers face higher interest rates and rising taxes.

“The Ministry of Finance, through its interaction within the G20 project on base erosion and profit shifting, is looking into ways to limit tax revenue losses from companies that evade tax through transfer-pricing abuse, misuse of tax treaties and illegal money flows.”

Mothata says the Treasury has lowered its expenditure ceiling in response to future potentially weaker tax revenue. It has also confirmed that the pace of hiring, especially at the provincial level, has slowed.

“However, the public sector wage bill remains elevated as the agreements on salary increases are negotiated for a three-year period. Compensation for government employees has risen 7.8% from the previous budget, showing there have been no significant public sector wage cuts.”

He notes that South Africa runs a fully funded pension system.

“The Government Employees Pension Fund, with assets of around R1.4 trillion, provides retirement security for about 1.3 million members. The Treasury has shown that a 1% increase in the wage bill results in an increase in pension liabilities of about R9 billion. If unchecked, long-term liabilities could increase.”

For Mothata the big question going into this Budget was whether Minister Gordhan would be able to turn the tide on the spiraling negative sentiment towards South Africa, and especially on whether a downgrade on the country’s debt to non-investment grade would be averted.

“Tax increases will improve the fiscus in the short term. However, given that capital gains tax increases have the potential to discourage investments, and that minimal structural reforms were announced, the jury is still out on whether the economy can cope with tighter fiscal and monetary policy,” he concludes.

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