Download Impossible balance

14 Rands and sense
Achieving an
Impossible balance
By: Bradley Mitchell, Head of Research, Sasfin Wealth
By: Mike Haworth, Investment Strategist, Sasfin Wealth
By: Alec Abraham, Senior Equity Analyst, Sasfin Wealth
So how about cutting back expenditure
The 2017 National Budget appears to be a slightly less demanding exercise than in 2016 on signs of a moderate, but still sub potential,
rebound in growth. However, it is important to note that this expected improvement in growth is being driven by factors that are out of
government’s control; namely higher commodity prices and a dissipating drought.
Sadly, opposing factors, many of which the government has influence, remain potential impediments to achieving and sustaining much
needed higher growth. This growth imperative remains crucial to offset the deficit imbalance that continues to face pressure from increased
current expenditure as a result of factors such as the growing social spending priority.
The main factors that would make the task of fiscal consolidation even more of a headache for National Treasury include the following:
•
Sustained low growth;
•
Execution risk;
•
Policy uncertainty; and
•
ZAR disruption.
Current Budget Position
1.3%
In the latest South African Reserve Bank (SARB) monetary
policy statement, a set of assumptions were provided, one
of which was the estimated potential output growths.
20161.3%
20171.4%
20181.5%
The concern is that these are still very low growth rates and
suggest a serious erosion of South Africa’s potential output
growth in the last few years. More importantly, it implies
that monetary policy is not as accommodative as it appears
at first glance.
The potential growth rate and related output gap form
an integral part of the price formation process in the
South African economy. The output reflects the degree to
which activities and processes in the economy are under
pressure from excessive demand and thus generating
inflation, or alternatively, under-performing and thereby
pointing to reduced inflationary pressures.
1.4%
1.5%
Estimated potential
output growths for 2016
Estimated potential
output growths for 2017
Estimated potential
output growths for
2018
15 Rands and sense
Revenue Growth
The three largest components of national government revenue
are personal income taxes (37% of national tax revenue),
company income taxes (17% of national tax revenue) and ValueAdded Tax (VAT) (25% of national tax revenue). These three
components contribute 80% of the national government revenue.
Total revenue growth for the fiscal year to date to November 2016
slowed to 7.1% year on year from 11.1% in the prior comparable
year.
This growth was largely derived from a 9% increase in personal
income and capital gains taxes, the largest contributors to total
taxes, while company taxes increased by 4.1%. This suggests
that the national government revenue imbalance persists.
Medium Term Budget
Adjustments
In the MTBR, National Treasury lowered its revenue forecast for
fiscal 2017, but a much lower consolidated expenditure reduction
resulted in the main budget balance deficit to still increase to 3.4%
of GDP.
Main budget balance deficit to increase by R8.7bn to R165.0bn
With this ongoing deficit, National Treasury highlighted the need
to institute consolidation measures. We continue to believe that
Treasury will aim to achieve this through proposed tax increases
combined with expenditure cuts each year through to 2019.
A concerning feature in the revenue mix is the decline in taxes on
payroll and workforce due to minimal job growth and a changing
job mix.
Even more troubling was the very low growth in net VAT revenues
up only 4.5% to R180.78bn.
The fundamental growth driver for tax revenue growth is personal
income taxes. As the National Treasury looks for more revenue
to compensate for low company and VAT tax revenue (this year
a R23bn revenue shortfall) it is planning additional tax increases
each year through to 2019. These increases are over and above
the R15bn announced in the Feb-2016 budget.
Budget Targets
In the MTBR, the expenditure ceiling was budgeted to increase
by a compound rate of 7.5% per annum over the next three years.
National Treasury has progressively lowered this expenditure
ceiling in nominal terms. The expenditure ceiling is the non-interest
spending financed from the National Revenue Fund and is one of
the key metrics watched by the international rating agencies to
ensure that SA maintains fiscal discipline given the low growth and
changing political bias.
Revenue Growth
The three largest components of national government revenue are
personal income taxes (37% of national tax revenue), company
income taxes (17% of national tax revenue) and Value-Added Tax
(VAT) (25% of national tax revenue). These three components
contribute 80% of the national government revenue.
Total revenue growth for the fiscal year to date to November 2016
slowed to 7.1% year on year from 11.1% in the prior comparable
year.
This growth was largely derived from a 9% increase in personal
income and capital gains taxes, the largest contributors to total
taxes, while company taxes increased by 4.1%. This suggests that
the national government revenue imbalance persists.
A concerning feature in the revenue mix is the decline in taxes on
payroll and workforce due to minimal job growth and a changing
job mix.
Even more troubling was the very low growth in net VAT revenues
up only 4.5% to R180.78bn.
Bradley Mitchell, Head of Research, Sasfin
The fundamental growth driver for tax revenue growth is personal
income taxes. As the National Treasury looks for more revenue
to compensate for low company and VAT tax revenue (this year
a R23bn revenue shortfall) it is planning additional tax increases
each year through to 2019. These increases are over and above the
R15bn announced in the Feb-2016 budget.
16 Rands and sense
Expenditure growth
Against the background of a non-interest expenditure ceiling, which was introduced in 2015 as an overt measure of fiscal consolidation, noninterest expenditure rose 4.5% in the year to date to November 2016.
The State debt cost was up 16.5% year to date to November 2016 on the back of continued rising net debt levels.
Debt levels in september 2016
Fiscal consolidation
Domestic debt The National Budget now allocates revenues exceeding R1 trillion
per year. Yet the quality of spending needs to be improved.
Too much public spending is regarded as wasteful, too much is
ineffectively targeted and too little represents value for money.
The Medium Term Budget Policy Statement (MTBPS) proposes
to narrow the budget deficit and stabilise debt. This policy of
fiscal consolidation is designed to prevent rapid capital outflows
and their consequent economic disruption, which would set back
transformation, and lead to higher unemployment and social
distress.
+R144bn to R1,963bn
National Treasury is attempting to balance the consolidation
between higher taxes and lower expenditure growth. Proposals
include a combination of tax policy measures that will raise an
additional R43 billion over the next two years, and reduce the
expenditure ceiling by R26 billion. These steps compound on
consolidation measures announced in the 2015 and 2016 Budgets.
Social spending is still getting
priority.
44.8% of GDP
Foreign debt South Africa’s gross public debt
stood at R2,156bn in September
2016, equivalent to 49.2% of GDP.
When public sector cash balances
are netted off the net public debt
level was R1,954bn, equivalent to
44.6% of GDP.
-R7bn to R193bn
4.4% of GDP
17 Rands and sense
Expenditure over the period 2017 to 2020
Health
Human settlement and
municipal infrastructure
+8.2%
Social protection
+8.0%
Post school education and
training
+8.2%
+9.0%
The lowest expenditure increases are in general public services up 4.1%, agriculture, rural
development and land reform up 4.8% and economic affairs up 4.9% over the period 2017 to
2020.
The consolidation measures proposed in this MTBR are likely to have some dampening effect
on economic activity. But the alternative over the medium term would likely be a further loss
of confidence and a ratings downgrade, which could trigger higher interest rates and large
capital outflows. The latter’s risks are greater risks to the economy than the likely effects of
fiscal consolidation.
Risks
Sustained low growth
Sustained low growth will force National Treasury to make more difficult allocation choices
as its current payment demands overwhelm the tax revenue received. This will compromise
government’s capital expenditure objectives and plans. It will also put increasing pressure on
National Treasury’s budgeted main budget expenditure ceiling. Personal income tax growth is
likely to come under pressure as corporate SA are likely to find it increasingly difficult to pay
8% per annum nominal wage growth when corporate gross operating surplus growth is as
low as 4% per annum. We estimate the population of SA’s major urban areas to be growing
at a rate around 5% per annum,made up of 1.7% population growth and the balance the
urbanisation rate. With a high urban population growth rate and low economic growth, minimal
employment growth can be expected. Therefore, urban social demands do not go away when
there is low growth, rather the social protection needs escalate.
National Treasury continues to increase personal taxes at the high end of the income spectrum
and the marginal tax scale continues to steepen. Indirect taxes, rate and taxes and utilities are
all set on steep sliding value and usage scales.
The progressive taxation (direct and indirect) will disposable income of the higher income
groups will come underpressure which will impact consumption growth. In the latest Quarterly
Establishment Survey to Q3:2016, formal sector community services and personal services
employment (most of which is public sector related) compensation growth was 10.4% YoY in
Q3:2016, slowing to 8.5% YoY in Q3:2016.
Alec Abraham, Senior Equity Analyst,
Sasfin Wealth
18 Rands and sense
Execution Risk
The main execution risk lies in wage growth. In this regard, the
expenditure ceiling has limited the hiring rate of public sector
employees. This may be easier to control in general administrative
positions but the growing urban population is placing greater
pressure on police, security, healthcare, education and social
welfare staffing. The largest inflation-linked expenditure is wage
growth. The key risk therefore lies in the under estimation of inflation
which could result in demand for higher wage growth.
Policy Uncertainty
Cabinet changes and politicking have been undermining National
Treasury’s effectiveness in the last 18 months. Rumours abound that
the President is about to reshuffle his cabinet again. The rumours
linger that the ANC leadership want to remove the Finance Minister
Pravin Gordhan. The attacks on Gordhan by the New Age and ANN7
media, calling him a “White Monopoly Capital” stooge, have
intensified and have been reinforced by opinion on his attendance at
Davos in January 2017.
In November 2016, the deputy finance minister Mcebisi Jonas was
quoted in the Public Protector’s State Capture report that he had
been offered R600m by the Guptas to become Minister of Finance.
Deputy Minister Jonas together with other senior politicians in the
National Executive committee are likely to be replaced after the
revelations in the State Capture report. This could place Finance
Minister Gordhan under more pressure from a new Deputy Finance
Minister and the ongoing power struggle with the Head of SARS.
The continued challenge by students using the “fees must fall”
campaign has already contributed significantly to unplanned
expenditure and this challenge does not appear to be fading.
Contingent liabilities associated with the State-owned Enterprises
(SOEs) including the Road Accident Fund (RAF). Government’s
major explicit contingent liabilities are its guarantees. The guarantee
facilities stood at R469.9 billion at the end of 2015/16, while the total
guarantee exposure was R263 billion at the end of 2015/16, since
several entities had not fully used their available guarantee facilities.
The largest guarantee exposure – more than R170 billion – supports Eskom’s capital investment
programme. An exposure of R200 billion relates to the IPPs.
The contingent liability risk is high in PRASA, SAA, SABC, RAF but looks to be reducing in the Post Office, SANRAL and the Land Bank.
South Africa’s Sovereign Credit Ratings
Rating Agency
Current foreign rating
Current domestic rating
Rating
Outlook
Rating
Outlook
Moody’s Investor Service
Baa2
Negative
Baa2
Negative
Fitch Ratings
BBB-
Negative
BBB-
Negative
Standard & Poors
BBB-
Negative
BBB
Negative
Investment Information Inc.
BBB+
Negative
A-
Negative
In mid-January 2017, Standard and Poors Global (SPG) warned that South Africa’s credit ratings still hang in the balance. The economic
growth trajectory still looks too low. The country’s rating being one notch above sub-investment grade leaves no room for error.
SPG also highlighted that 2017 looked likely to be busy politically because the African National Congress (ANC) is heading for an elective
conference which could result in changes in government.
Further ministerial changes and increased litigation undermines policy implementation, which elevates the risk of credit downgrading
significantly. Other risks such as “fees must fail” demands, persistent contingent liabilities in State Owned Enterprises and growing social
support pressures look unlikely to abate in fiscal 2018.
The international credit rating agencies repeatedly cite the strength and independence of its key institutions as a key factors protecting the
constitutional base of South Africa and providing a backbone to the investment grade ratings. These key institutions are:
•
National Treasury,
•
The Auditor-General,
•
The Reserve Bank,
•
The Independent Electoral Commission,
•
The Public Protector, and
•
Judiciary and the courts.
19 Rands and sense
ZAR disruption
The continued and intense politicking around National Treasury
raises doubts about its continued independence.
The Reserve Bank is seen to be independent and that monetary
policy is conducted independently to maintain price stability in the
context of weak growth and is not a pawn in the State political power
struggle.
The Public Protector’s office has a new Public Protector in Busisiwe
Mkhwebane who replaced Thuli Madonsela when her tenure ended
in 2016. In the new Public Prosecutor’s first 100 days she has
asked the police to probe the leaking of the audio recording of
Madonsela’s interview with President Jacob Zuma and shelved the
former Public Protector’s State Capture report. The independence of
the Public
Protector’s office is now in some doubt. This is reinforced in the
timing of a preliminary report by Public Protector Mkhwebane
provisionally finding that the apartheid-era bank bailout of Bankorp
was unlawful and Absa Bank could be forced to pay R2.25‑billion
to the fiscus. Absa responded describing the preliminary report as
containing “several factual and legal inaccuracies” which distort the
context and hence judgement.
The judiciary is increasingly being overwhelmed by South African
politics which is becoming progressively more litigious. While this
is substantially boosting demand for legal and court services, it is
placing an increasing financial burden on government expenditure
and extending the courts case backlog. Both factors are eroding the
judiciary system effectiveness. The latest court battle between the
Guptas and Gordhan is a further distraction for the Finance Minister.
Mike Haworth, Investment
Strategist, Sasfin Wealth
The strengthening ZAR is driven by yield seeking foreign portfolio
capital inflows is likely to be disruptive given the very slow expected
real growth and static or slowing nominal GDP growth in the South
African economy in 2017 and the rising risk of increasing US
protectionism and its negative influence on already slowing global
trade.
In Summary
National Treasury’s task of lowering the budget
deficit and slowing the rise in public debt to
GDP continues to pose a challenge, particularly
in the context of weak, albeit improving,
domestic economic growth and growing
structural imbalances.
Even though the need for fiscal discipline in South Africa remains
critical, the consolidation measures are likely to have some
dampening effect on economic activity. But the alternative over
the medium term would likely be a further loss of confidence and
a ratings downgrade, which could trigger higher interest rates and
large capital outflows. The latter’s risks are greater risks to the
economy than the likely effects of fiscal consolidation
In conclusion, faced with a plethora of risks that could upset the
potential to reduce the budget and fiscal deficits, tax payers,
particularly high income earners, will be forced to carry a greater
portion of the of the deficit reduction burden.