The Medium-Term Budget Policy Statement (MTBPS) on 24 October, promises to be one of the more important in South Africa’s recent history, given the faltering economy, strained fiscal status and ongoing concern regarding the risks of further credit rating downgrades and tax hikes, says Dr Adrian Saville, chief executive of Cannon Asset Managers.
He said that minister of finance, Tito Mboweni, is unlikely to introduce any major policy changes in the speech. However, it is likely that the MTBPS will be used to flag key constraints on economic recovery, and institute clear calls to action to release the constraints that keep South Africa bound to a low growth path.
“To reach economic growth levels of above 3%, the country needs to achieve an investment level of at least 30% of gross domestic product (GDP). Currently, our investment rate is just two-thirds of that required rate, around 19%.
“This low investment rate means that government not only needs to restore domestic investor confidence through delivering greater policy certainty, but the country also needs to attract foreign capital by appeasing credit ratings agencies, which will be closely scrutinising the MTBPS for evidence of the country’s economic direction,” he said.
Saville identified five critical areas of concern that investors, ratings agencies, tax payers and citizens at large should be watching for in this year’s MTBPS:
1. Low economic growth
In the run-up to his election as head of the ANC, president Ramaphosa had promised to deliver a better economic environment and reignite economic growth. Instead, the 1.5% growth for 2018 projected in February’s Budget Speech is likely to be revised downwards in the MTBPS after the country officially entered a recession in the second quarter.
“This year’s MTBPS will be read by the new Minister of Finance, Tito Mboweni, in an environment in which the ‘Ramaphoria’ seen at the beginning of the year has exited stage left, so to speak. This reflects the fact that the promise of fast economic growth simply hasn’t materialised,” said Saville.
“We can therefore expect to see some reference to the obviously disappointing global environment to help account for why this growth is missing.”
He argued, however, that while external factors such as turmoil in emerging markets have played a role, poor economic growth remains at least partly attributable to the legacy of weakened institutional fabric and frail investor confidence that is associated with former president Zuma’s administration.
“On a more positive note, we should see some recovery in growth as we enter 2019. Notably, though, ratings agencies are more concerned with per capita economic growth than GDP growth,” he said.
“Given that the population growth rate currently stands at 1.7%, we would need economic growth of 1.7% or higher to see a meaningful improvement in the country’s per person wealth. Once we dip below the 1.7% mark, the country’s per capita income falls, and by this metric the country has been in a recession since 2014.
“Equally startling is that over the past ten years, economic growth and population growth have each averaged about 1.7%. This means per capita income in South Africa has gone sideways for a decade,” Saville said.
2. Tax buoyancy
The next key issue is evidence of the country’s tax buoyancy – or lack thereof. This refers to increases in revenue collection that accompanies economic growth or, as things are now, an economic recovery.
“Government had to raise VAT in February this year because of low tax buoyancy and absent economic growth rates. This will give the ratings agencies and investors cause to look for direction from the MTBPS on what tax collections currently look like, how this squares up relative to the country’s debt levels, and whether government will need to look for new sources of revenue given government’s spending requirements and revenue stresses,” Saville said.
On this front, however, he added that there is some good news. Over the first part of the 2018/19 fiscal year, revenue collections were up 11.2% year-to-date, versus the forecast increase of 10.6%.
“This implies that National Treasury is on track to exceed the budget revenue forecast in the year ending March 2019, which will mean a lower-than-expected budget deficit.”
3. Government debt
Following on closely from concerns around low tax buoyancy, ratings agencies remain vocal about the country’s rising debt levels and high budget deficit. Notwithstanding the previous point that the deficit might come in lower than expected, the budget deficit for 2018/19 is expected to come in around 3.6% of GDP.
“This is much higher than forecast economic growth. As a result, we are likely to end the 2018/19 fiscal year with a debt-to-GDP ratio of a little over 55%, which is close to the widely-accepted rule of thumb of a 60% debt-to-GDP ratio representing a clear warning signal of fiscal stress,” said Saville.
Minister Mboweni is therefore likely to report back on government’s efforts and progress in terms of expenditure containment and debt consolidation.
“However, given that the country is entering an election year, the minister is unlikely to address the elephant in the room, namely the size of the public service and government wage bill,” he said.
Government consumption as a percentage of GDP is close to 25%, the largest component of which is the public sector’s wage bill. Government employment further accounts for 25% of total South Africa’s employment, which compares to countries such as Chile at 15% and Turkey at 12%.
4. The state of State-Owned Enterprises (SOEs)
The roughly 55% debt-to-GDP ratio masks an additional 15% debt in government guarantees for SOEs.
“To go full circle, the financial recovery of SOEs is therefore also key to getting economic growth and investor confidence back on track. It’s hard to imagine an environment where SOEs remain underfunded, with large debt overhangs and operating deficits, and in the same breath to discuss achieving a rate of 3% economic growth or even higher.”
“Ratings agencies will therefore be looking for pragmatic action in terms of righting SOEs such as Eskom, the South African Post Office, the SABC and South African Airways (SAA) to reverse their deficits, establish operational efficiencies, restore the health of their balance sheets and re-establish investor confidence,” Saville said.
5. Social issues
Finally, the three critical social issues that continue to plague the country’s prospects and that are likely to receive attention within the MTBPS are land reform, unemployment and education.
First, Saville pointed out that land reform represents an extraordinary opportunity for South Africa, given the country’s vast tracks of underutilised land.
“Historically, the agricultural sector in South Africa has demonstrated globally competitive components, which means that we have one of the critical ingredients needed to excel in the sector, namely land.”
“The barriers to entry in agriculture are also particularly low, and the development of the sector would help South Africa square up to the second critical issue which is the persistent, elevated unemployment crisis, particularly amongst the youth.”
It goes without saying, though, that for this to come about, ownership of land must be accompanied by skills; access to finance; access to key inputs including equipment, chemicals and infrastructure; and routes to market, Saville said.
He added that in terms of unemployment, the minister of finance also is likely to mention the Youth Employment Service (YES), gazetted in the beginning of October, as part of efforts being made to address the country’s youth unemployment crisis.
“YES is a fantastic initiative that demonstrates what is possible when business, labour and government collaborate and co-ordinate around critical social issues with common purpose. The initiative will possibly receive comment within the MTBPS as a distinct positive in terms of the country’s progress under the Ramaphosa administration,” he said.
However, even if the country can “fix” issues of land reform and unemployment, the third glaring hole in South Africa’s economic prospects remains the country’s poor education outcomes.
“We are therefore also likely to see some messaging around the education sector, and hopefully some clear calls to action in terms of improving the education system,” Saville said.