Finance minister Mboweni’s upcoming medium-term budget speech provides government with an opportunity to elaborate on how it plans to achieve the economic proposals it outlined in its August discussion document.
Sanisha Packirisamy, an economist at Momentum Investments, says that the minster will need to address a number of issues hampering economic growth, to keep ratings firm Moody’s from downgrading the country’s investment rating.
In a nutshell, Momentum Investments said that political will and faster growth is needed to escape South Africa’s fiscal plight.
Packirisamy said that Moody’s methodology is still likely to produce an investment grade outcome for the country’s sovereign rating on 1 November 2019. “There is a higher-than-even chance, in Momentum Investments’ opinion, for lowering the outlook from stable to negative to flag rising fiscal risks,” the economist said.
The financial services firm outlined 10 areas that need Mboweni’s attention when he delivers his budget speech on 30 October.
The economy is limping along
Regulatory and macroeconomic policy inertia, accompanied by mounting uncertainty, has scuppered investment activity in recent years, said Packirisamy.
“Growth in domestic fixed investment has averaged a mere 0.1% in the past five years, while employment statistics worsened.
“The number of discouraged work-seekers – those who have given up looking for work for a period longer than four weeks – rose by 640,000 and the number of unemployed persons deteriorated by 1.3 million during this period.”
Momentum said that lacklustre demand and high policy uncertainty will weigh on growth forecasts in the near term.
It estimates that real GDP growth of 1.2% between 2019/20 and 2021/22 in comparison to Treasury’s forecast set in February 2019 of 1.8%.
Similarly, it expects headline inflation to average at a lower 4.7% in the corresponding period in comparison to Treasury’s February 2019 estimate of 5.4%.
Using these real GDP growth and inflation forecasts to proxy the outcome of the nominal GDP deflator, the firm sees 1.3% downside to Treasury’s forecasts between 2019/20 and 2021/22, which could further burden revenue collection, Packirisamy said.
Tax collection is lagging
Growth in government revenue has disappointed in the fiscal year – for the first five months of FY19/20 – relative to the average for the past five years, Momentum said.
The disappointment in revenues has permeated throughout all three of the major revenue contributors. Growth of 6.9% in personal income tax (PIT) collections year to date is significantly below the average for the same period in the past five years of 10.5% and is trailing government’s February 2019 assumption of 12.4% by a large margin, it said.
Extrapolating tax receipts year to date points to a R97.9 billion shortfall in tax revenue for FY2019/20 but after taking account of seasonality and a normalisation in VAT refunds, the shortfall falls to around R50 billion.
Momentum noted that revenue shortfalls have widened in the past five years, as revenue under-collections have increased from R7.4 billion in fiscal year 2014/2015 (FY2014/15) to R57 billion in FY2018/19.
“Tax shortfalls have occurred in spite of the implementation of additional tax hikes, including the 1% VAT increase and an increase in taxes for the top tax bracket,” it said.
“There is a growing concern that the country has approached its limit on advancing tax revenue collections through further tax increases for taxpayers,” said Packirisamy.
Limited room to raise additional taxes
Momentum said that personal income tax (PIT) accounted for a larger share of total tax revenue in 2017/18 at 38.1% from 29.6% in 2007/08.
Tax shortfalls have occurred in spite of the implementation of additional tax hikes, including the 1% VAT increase and an increase in taxes for the top tax bracket, said Packirisamy.
“There is a growing concern that the country has approached its limit on advancing tax revenue collections through further tax increases for taxpayers.
“The Laffer Curve – the relationship between tax rates and the amount of tax revenue collected by governments – suggests at some point, further tax increases will eventually lead to lower tax revenues being generated as the disincentives of higher taxes start dominating collections.”
Momentum said that the burden on South African households has climbed further with fuel levies having increased as a proportion of total revenues during the same period.
“Additional hikes to the VAT rate and CIT are unlikely at this stage. Meagre consumption spending by consumers argues for stable VAT rates after the hike to 15% in April 2018, while relatively high CIT rates and government’s desire to draw foreign direct investment towards the country suggests little scope to raise CIT rates further,” Packirisamy said.
Pressure to cut expenditure
As part of the February 2019 national budget, government said it had reduced departments’ budget baselines by R50.3 billion relative to the 2018 medium-term budget, of which nearly half related to compensation.
It also said that it would cut the civil servant wage bill by R20.3 billion over three years. This would be accomplished by encouraging early retirement for employees between the ages of 55 and 60, through the removal of penalties.
Despite these initiatives, the 2019 national budget outlined an expected increase in the government wage bill from R627.1 billion in 2019/20 to R713/1 billion in 2021/22.
Risk of breaching the expenditure ceiling
Despite the proposal to cut expenditure growth in the next three fiscal years and potential underspend on capital budgets, additional allocations to state-owned enterprises are expected to pose a significant risk to breaching the expenditure ceiling, said Packirisamy.
In July 2019, the Special Appropriation Bill provided for additional financial support to Eskom of R26 billion for 2019/20 and R33 billion for 2020/21.
South African Airways (SAA), Denel, and the South African Broadcast Corporation (SABC) have also received multi-billion-rand bailouts this year.
Momentum Investments said that policy uncertainty continues to stymie growth efforts in the economy.
The Bureau of Economic Research’s Manufacturing Survey points to 83% of manufacturers holding off on investment as a consequence of prevailing policy uncertainty, the group said.
“Some progress has been made on reforming the struggling economy, but big business is growing impatient with Ramaphosa’s trickle-through approach to reform and government’s discernible inertia on critical reforms at SoEs,” said Packirisamy.
The economist warned that the president’s vague responses on contentious reforms, including land expropriation without compensation, the national health insurance, prescribed assets and the sale of ill-functioning state entities are a function of ideological tensions, which are likely to elicit a polarised response from within the ruling party’s structures.
It could influence broader support for Ramaphosa going into the 2022 ANC National Elective Conference.
Early estimates by National Treasury suggested the cost of the NHI programme will reach R256 billion a year by 2026, Momentum Investments said.
However, a number of experts suggest this number is grossly understated and Econex calculated the NHI costs in 2017 to be closer to R369 billion a year by 2025/26.
Many obstacles lie ahead for the NHI programme to be rolled out, said Packirisamy.
South Africa also suffers from an acute shortage of qualified medical professionals, specifically general practitioners, medical specialists and nurses.
Moreover, there is likely to be a larger administrative burden associated with the NHI programme and innovation in health care may be stifled, the financial services group warned.
At its 54th national conference in 2017, the ruling party endorsed a policy resolution stating “a new prescribed asset requirement should be investigated to ensure that a portion of all financial institutions’ funds is invested in public infrastructure, skills development and job creation”.
Momentum Investments said that the re-introduction of prescribed assets would likely result in a misallocation of capital and could crowd out foreign participation in SA’s government bond market.
“Prescribed assets are currently not government policy and there is no detail regarding what asset classes it may include or the time horizon may be applied, making it difficult to estimate the consequent impact on asset classes,” it said.