Finance minister Pravin Gordhan is under increasing pressure to find funds to bulk up the state coffers, and he is running out of options for where to find them.
The minister will deliver his Budget speech on 22 February, where he will lay out a plan to draw in R28 billion more in tax revenue over the next two years.
According to Nomura research analyst Peter Attard Montalto, Gordhan sits with a particular challenge, given the political backdrop his budget has to play out in front of – while being hit by both the macro- and micro-economic factors South Africa faces.
Politically, Gordhan has to balance the ANC’s new “radical transformation” rhetoric with more solid economic realities. Notably, Gordhan has to work to keep ratings agencies at bay, while limiting political pushback.
“We think a slightly flatter real growth outlook from the NT will be marginally offset by a slightly higher GDP deflator, but the net result will still be lower medium-run nominal growth,” the group said.
“At the micro level the key issue in this Budget will be revenue-side adjustments. Since the 2015 Budget unspecified revenue increases have been increasingly pencilled in and have been a key uncertain hole in the Budget.
“We have no doubt that the NT can fill the R28 billion of measures pencilled in for the coming fiscal year and these must be announced this week. However, we think it will take a scatter-gun approach as follows to raise the amount,” Nomura said.
According to Nomura, these are the most likely avenues Gordhan will explore to draw in the R28 billion in tax he needs in 2017:
Fuel levy increase
“We expect this to do the heavy lifting and raise around R2.2 billion per 10 cent increase in the levy.
“We expect around a 75 cent increase, which would raise some R17 billion in revenue.”
“We expect a bracket creep in personal taxes (ie below inflation increases in bracket levels sweeping more income into higher rates) and the possibility of a new higher income tax bracket rate (or possibly an increase in the current top rate of tax).
“Together these should raise a relatively small R5 billion because of the narrow tax base being targeted.”
Estate duties, capital gains and sin tax
“We expect small changes to estate duties, capital gains taxes and sin taxes to raise the remaining R6 billion.
“The risks are for a smaller rise in the fuel levy and a larger increase in other tax changes.”
While Nomura believes that a VAT hike of one percentage point probably won’t show up this year, it is probably inevitable.
“We think a 1pp increase in VAT will have been placed on the table as an option (raising R15 billion) but rejected because it has too large a political and economic impact,” the firm said.
“A VAT increase is likely to eventually be needed – and we think this is a missed opportunity for an efficient tax with appropriate zero rates to protect the poor.
“If future unspecified revenue increases are added at this time, we would expect those to be VAT increases with a much higher probability,” it said.
Nomura said that it does not expect there to be any ’emergency’ rating action following the Budget speech, but a downgrade is still likely in 2017 – especially from S&P – to bring external and internal ratings in line.
The first ratings action for 2017 is Moody’s on 7 April and where a downgrade is possible Though not to junk, as the firm still has SA two notches above junk), but this may well only happen during Moody’s 11 August ratings update, Nomura said.
S&P will likely cut South Africa to junk at its 2 June update, given declining fiscal flexibility and possible shocks from Eskom, the group said.
Like Nomura, George Herman, head of South African Portfolios, Citadel said that Gordhan does have several options open to him, “but we must be cognizant of the fact that he is likely to opt for a middle road in his choice of solution – so some are far less likely to be utilised”.
“He will be helped in his task by fiscal drag: as salaries rise to match inflation, taxpayers are pushed into increasingly higher tax brackets thus netting additional revenue for the fiscus.
“For this reason, I don’t expect much by way of bracket relief – I don’t think that he will adjust the tax brackets as much as would be suggested by the current rate of inflation, other than perhaps for the lowest income bands. In fact, it’s more than likely that the tax rate for the top bracket will be increased by 1%. These two measures alone should bring in an additional R10 billion of revenue,” Herman said.
The analyst said that while the minister has the choice of increasing the VAT rate by 1% which could deliver as much as R20 billion, “this is extremely unlikely in such a politically sensitive year”.
“What’s more probable, in light of the president’s State of the Nation Address on 9 February, and given his tone and language, is an increase in Estate Duty and even a doubling of Capital Gains Tax. Together, these two measures could deliver as much as R5 billion in additional tax revenue,” Herman said.
“If the minister succeeds in balancing these opposing variables, South Africa could well avoid a credit rating downgrade. However, should we face the expected political turmoil during the ANC’s presidential election year, both bond yields and the rand could come under severe pressure,” the analyst said.