This is what ratings agencies will be looking out for in Wednesday’s budget speech
Wednesday’s budget speech comes amid significant political change, with the prospect of another ratings downgrade still looming over the economy. However, markets have reacted positively to the election of Cyril Ramaphosa as president of South Africa.
Many international observers will be watching the budget, to be delivered by finance minister Malusi Gigaba, closely.
“What Gigaba – assuming he retains his position – says will have an effect on the rand: we need to see indications that the deficit will be narrowed, and that borrowings will not increase,” said Tsitsi Hatendi-Matika, market analyst at Absa Wealth and Investment Management.
The finance minister has to deal with the fact that revenue will be about R50 billion lower than what was anticipated in the February 2017/18 budget, which was presented by then minister Pravin Gordhan.
Value Added Tax (VAT) has been a lever that the National Treasury refused to pull for years, likely because of its political consequences, but a 2% increase in VAT would create the much required cash. An increase in VAT is expected to signal government’s commitment to addressing the issue of fiscal slippage.
An alternative to increasing VAT in a linear manner would be to remove the zero rating for VAT on fuel sales. Absa anticipates that this could raise up to R18 billion.
“Given that this would increase the retail price of fuel, if not offset by a cut in the General Fuel Levy, this means that National Treasury would need to get creative around this for it to be palatable for consumers,” said Hatendi-Matika.
The Davis Tax Committee has studied alternatives available with respect to taxing the wealthy in many different ways, and it had an opinion, which was against measures such as a luxury rate of VAT. On the upper end of the tax spectrum, tax rates are 45%, which is viewed by some as punitive.
“In a country like South Africa where the top 5% of the wealth bracket carries the bulk of the tax burden, the risk of the top end retaliating against further taxes is becoming a reality,” the analyst said.
National Treasury is expected to introduce measures to increase the pace of the deficit reduction. “The ability of National Treasury to address primary budgetary issues, if done right, will be a game changer, not only for the capital markets but also for the man on the street,” said Hatendi-Matika.
“The fiscal slippage has been startling as the deficit has been more than a percent higher than what was tabled in February 2017. The public sector wage burden has been a significant detractor as the wage bill has spiraled out of control over the last decade.
“The current wage agreement is expiring in the next month and a new three-year deal increasing at a rate of inflation should be expected. This has not been confirmed, and could derail the anticipated expenditure numbers should there be any change in the rate of increase.
“To add a further spanner in the works, former president Jacob Zuma skillfully threw in the promise of free education during the December ANC conference and this is now a promise the party needs to figure out how to fulfill. It is estimated that up to R60 billion would be necessary to allow for free tertiary education,” said Hatendi-Matika.
Absa stressed that governance issues and clarity around the funding of State-owned companies (SOCs), namely Eskom, SAA and the Post office remains a top priority.
Close to R35 billion is required in bailouts, with Eskom taking up around R20 billion of this amount. The SOCs have put a major strain on contingent liabilities, as the government continues to give guarantees when these entities borrow. This has been the focal point of concerns raised by international rating agencies, the financial services group said.
It noted that Moody’s is the only rating agency which has South Africa above investment grade. The negative outlook it placed on the country’s rating will expire end of February, allowing enough time for its analysts to digest the budget and make a final decision.
“SA Inc. doesn’t need another negative rating. We need to capitalize on our great resources, for the benefit of this great continent,” said Hatendi-Matika.
Consumer confidence
Standard Bank economist, Elna Moolman, said that a number of positive signs are emerging that could see consumers helping drive economic growth forward.
While the expectation is that wealthier taxpayers and those consuming alcohol, cigarettes and sugar sweetened beverages will be hardest hit, Moolman said that consumers should experience lower inflation this year at an average of 4.4%, from last year’s 5.3%.
“So if wage growth is around 6.5%, it would mean real wage growth of around 2%. This is the key driver of consumer spending growth in the coming year, and in turn we expect the consumer to drive economic growth to a large extent in 2018, despite the tax increases,” she said.
According to Moolman, it is also possible to avoid a downgrade – for now. “But it is a very close call and will require decisive government action,” said Moolman.
While a VAT rate hike is being widely touted as one of the quickest ways to rake in more revenue for a stretched fiscus, Moolman is not convinced.
“In a low-savings economy, consumption should rather be taxed, but I think a VAT hike is likely to be politically unpalatable ahead of the 2019 national elections in particular. It is difficult to completely avoid a negative impact on the poor, and there is a debate about the degree to which it may be regressive. We suspect adjustments to increase the effective VAT rate are more likely than a general VAT rate increase,” she said.
On the negative side, though, broad-based fiscal drag is becoming a greater concern every year as tax brackets are not adjusted for inflation in the Budget – dragging people earning higher salaries to keep up with inflation into higher tax brackets. Only modest relief for the lowest income groups can be expected this year.
Those who enjoy sugar-sweetened beverages can also expect to pay more to indulge from April as the Bill introducing the sugar tax has been passed and is due for implementation from April 2018. “This could yield additional tax revenues of around R1 billion-1.5 billion,” said Moolman.
On the wealth tax front, estate duties could be increased from the current 20%, lifting it to 30% – alongside a similar increase in donation tax. This would yield an extra R1.5 billion of revenues, according to Standard Bank estimates. Normal sin tax increases on tobacco and alcohol should yield an additional R2.5 billion in revenue.
It is important to place the budget in context after Gigaba signalled total revenue increases, including tax hikes and any assets that government can sell, of around R30 billion in the coming fiscal year.
“So while the tax hike portion of the increases will weigh on the consumer, it is important to note that this is not the only area government is looking at.
“If last year’s tax hikes were estimated to be worth around R28 billion, and we get around R25 billion of hikes this year – with potential asset sales helping get to the R30 billion revenue increase estimate – then it is not more than what consumers faced last year,” said Moolman.
Read: Wealthy South Africans likely to be targeted by new tax: analyst
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