Budget analysis: all you need to know

Budget analysis: all you need to know

By Claire Bisseker, 26 October 2016, financialmail.co.za.

SA has reached its fiscal limits and unless growth recovers, the government is going to strain to fund those policies it already has, let alone introduce new ones.

This was the sober message finance minister Pravin Gordhan delivered in Parliament on Wednesday in presenting SA’s 20th medium-term budget policy statement.

A heavy cold wasn’t the only burden the finance minister shouldered. Next week he will appear in court on fraud charges and his speech, though tough fiscally, contained little in the way of growth-enhancing reforms on which to pin a sustainable economic recovery.

Although the “green shoots” of a cyclical upturn are visible, the treasury has had to revise down its GDP growth forecasts for the fifth year in a row.

It is now expecting growth of 0.5% this year, rising to 1.3% in 2017 and 2.0% in 2018 compared to 0.9%, 1.7% and 2.4% previously.

The economy’s failure to grow means revenue is set to fall short of budgeted targets by a massive R23bn in the current fiscal year. And given the tepid recovery forecast, large revenue shortfalls will persist over the medium term, forcing treasury to take stronger steps to rein in rising public debt.

To prevent significant fiscal slippage, Gordhan will cut expenditure by a further R26bn over the next two years while raising taxes by an additional R43bn.

This comes on top of the already significant fiscal measures announced in the February budget and far exceeds the adjustment most economists expected.

“In simple terms, South Africa’s tax burden is going to rise very sharply over the coming years,” warns Stanlib chief economist Kevin Lings.

Treasury officials were reluctant to discuss the specific tax policy implications of the budget statement but confirmed that whereas once they had sought to retain the option of a VAT hike to fund National Health Insurance, it might now be needed to fund existing policies.

The treasury concedes in the policy statement that the effect on economic activity will be “somewhat dampening” but counters that the consequences of not acting — a further loss of confidence and a ratings downgrade — would have been worse.

This is not to say the medium-term budget policy statement does enough to prevent a ratings downgrade.

“The credit rating agencies will assess the latest setback in government’s fiscal parameters, together with rising social tensions that threaten to spill over into widespread social unrest, political in-fighting, and the lack of progress in inspiring private-sector investment and job creation,” says Lings.

“Against this backdrop, it’s going to be extremely difficult for SA to maintain its current investment-grade credit rating without a realistic growth strategy.”

It has proven impossible, given the hand that the treasury has been dealt, to prevent some fiscal slippage.

Though the consolidated budget deficit is expected to come in just 0.2 of a percentage point below target at 3.4% this fiscal year, the pace of reduction is set to slow over the medium term.

The deficit will now hit 2.5% only by 2019/2020 — a year later than before. Moreover, net loan debt, which was supposed to stabilise at 46.2% in February 2016, will now stabilise at 47.9% in 2019/2020.

Gross debt is projected to peak at an uncomfortable 53% of GDP in 2018/2019, from 51.3% now, before subsiding.

The goal of achieving a primary surplus has also been pushed out from the current fiscal year to 2017/2018.

The only comfort that can be taken is that the slippage is due to anticipated revenue shortfalls rather than expenditure overruns and that the treasury has responded by not borrowing significantly more.

The treasury has not only stuck to its expenditure ceiling, but is proposing to reduce it by a further R10bn in 2017/2018 and R16bn in 2018/2019.

To do so, it plans to cut the operating budgets of all national departments by 1.1% as well as reduce transfers to some public entities. Large conditional grants to provinces and local government, which tend to be underspent, will also be trimmed.

Post-school education, on the other hand, will receive an additional R17.6bn in the 2017 budget, with the pace of spending on this item set to grow by 9.2% in nominal terms on average over the medium term.

The treasury has also delivered on its undertaking to stabilise spending as a percentage of GDP and has moderately reduced the public service headcount.

Significant further cuts to headcounts will, however, be needed over the medium term unless workers accept a less generous wage dispensation from 2018.

Budget Office head Michael Sachs stressed to journalists in a technical briefing that this was not an austerity budget.

Not only is non-interest spending still set to grow faster than inflation but it follows a massive ramp up in government spending over the past 20 years during which per capita spending doubled.

Total spending now exceeds R1-trillion a year. But this has come at a cost. Government debt now exceeds R2-trillion and rising debt service costs are crowding out expenditure on priorities such as infrastructure and education.

However, in moving to stabilise SA’s debt, the treasury was mindful that more aggressive fiscal consolidation — though it might bolster investor and business confidence — could ultimately prove self-defeating if it reduced GDP growth, leading to lower revenue and higher deficits.

Doing nothing, on the other hand, could lead to ratings downgrades, capital flight, rapid rand depreciation and a spike in interest rates, possibly resulting in even lower growth and ultimately a low growth trap, the policy statement warned.

In avoiding these extremes, Gordhan has coined the term “measured fiscal consolidation” to describe the balancing act the budget performs.

While the budget policy statement is not antigrowth, it is more explicit than previous budget documents in spelling out that as long as the economy doesn’t grow, SA cannot afford existing levels of expenditure — let alone new policies.

It warns that “realistic trade-offs” will have to be made because the space to increase taxes is limited and cannot accommodate all the new proposals that have been tabled in health, education, defence, social development and infrastructure.

To put it bluntly, as the policy statement does, “long-term policy aspirations far exceed available resources”.

The key takeaway from Gordhan and treasury officials is that everything possible must be done to rebuild confidence in SA in order to bolster fixed investment on which growth depends.

This meant making the right fiscal and policy choices, Gordhan told journalists, and would require an “unqualified focus on growth” as well as further stakeholder cooperation in order to nurture a common sense of purpose.

Of course, the budget may not mean much if its author is not around to implement it, notes John Ashbourne of Capital Economics.

“Efforts to oust the respected finance minister continue,” he says. “But the warm welcome Gordhan received from parliament did suggest that support for the embattled minister is growing.”

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