By Paul Marais and Amy Degenhardt
Finance Minister Tito Mboweni’s much-anticipated supplementary budget speech addressed the ‘dangerously overstretched’ financial situation in which South Africa finds itself due to the impact of the Covid-19 pandemic. The purpose of this budget was to create a platform for a sustainable fiscus by stabilising debt while providing the financial means to look after the country’s citizens.
Several key items from the minister’s speech stand out: tax reforms, foreign funding, the public sector wage bill and zero-based budgeting.
The speech itself was devoid of concrete tax reform proposals, though some were included in the supporting material. Delving into the full budget proposal, the government highlights that its approach to improving tax revenue will be three pronged: improved tax collection, additional tax measures, and recovering economic activity.
It was noted that these additional tax measures will only be addressed in detail during the February 2021 Budget.
Increasing taxes is a very narrow bridge to cross. Lifting corporate tax rates is almost a non-starter given that government policy in the last few years has been in the opposite direction. The supplementary budget also highlighted that, in order to support growth, focus would be placed on making it easier to do business in South Africa. Increasing corporate tax would contradict this stance.
The budget specifically identified international taxes as a way to increase tax revenue, through transfer pricing. This would most impact companies that house multiple legal entities stretching across borders.
Personal income taxes also have limited room to manoeuvre. It is however likely that we will see no inflation-adjustment to offset bracket creep, and that the maximum marginal tax rate will go up.
Wealth taxes and capital gains taxes are politically palatable, but the amount of revenue they generate is immaterial when considering that between 2021 and 2025 government would like taxes to increase between R5bn and R15bn each year. Also, one wonders just how much capital gains are available in the system to be taxed given the market environment.
An increase in VAT is another option, but given the extreme levels of poverty, a consumption-based tax is a political non-starter. Zero-rating more goods and services will ease some of this, but doing so would raise questions about the materiality of further VAT increases.
The budget speech was clear about the need to look for foreign sources of funding for the government’s budget deficit, to the tune of $7bn. The current intention is to borrow the majority in a $4.2bn loan through the IMF’s rapid financing instrument, and further $1bn through a loan from the New Development Bank (formally known as BRICS Development Bank).
Whilst IMF and BRIC’s loans come at attractive interest rates, they are expected to be repaid in hard currency. This changes the mix of foreign to local debt and will inevitably lead to higher local interest rates to compensate investors for the risk that some of government’s resources are going to be priced in a currency almost guaranteed to weaken over time.
Public Sector Wage Bill
The massive R160.2bn public sector wage bill has yet to be addressed. It clearly wasn’t in the budget speech as negotiations appeared to have been delicately poised at the time.
Simply pausing on the three-year deal will be a massive achievement, but what really needs to happen is that the bloated public sector needs to be held to account and the wage bill needs to be redistributed. Ratings agencies, such as Fitch, anticipate any wage negotiations to be difficult, predicting that adjustments to the bill may not even be possible until the April 2021 expiry of the agreement.
One does wonder, and this is somewhat speculative, whether President Ramaphosa’s administration has built enough goodwill through their coronavirus crisis response consensus building approach to have a real shot at addressing the public sector wage bill without massively compromising the portion of the electorate those wage earners represent.
Zero-based budgeting is a wolf in sheep’s clothing, which could be catalytic if Treasury gets it right. Doing the budget this way forces every single line item to be justified and accounted for and leaves very little place to hide wasteful expenditure. Zero-based budgeting also includes the phasing out of programmes that lack service delivery and have minimal impact on economic performance.
It is, however, an onerous process and does need to be given time to be appropriately ventilated and vetted to prevent it from being undone in years to come. The last thing our country needs from a fiscal perspective is to have savings on expenditure frittered away by political infighting and the inertia that will inevitably result.
Unfortunately, South Africa was battling financial difficulties before the global pandemic struck. The supplementary budget served to confirm the dire state of South Africa’s finances and battled to convince economists and rating agencies of a stable growing economy.
In direct response to the emergency budget, Fitch detailed their concerns about South Africa’s ability to stabilise debt in four years. With lower than anticipated revenues and higher than anticipated debt to GDP, there is a tough road ahead for South Africa.
Paul Marais is MD and portfolio manager at NFB Asset Managment. Amy Degenhardt is an investment research analyst at NFB Asset Management.