Government’s finances continue to improve, but overall risk to the fiscus remains unchanged

Finance minister Enoch Godongwana delivers his widely anticipated maiden budget speech on February 23 amid expectations that he will announce that the government’s finances continue to improve at a much faster pace than was anticipated by the National Treasury in the medium-term budget policy statement (MTBPS) in November last year.

Despite the upbeat revenue forecasts and welcome social relief spending, the overall risk to the fiscus remains unchanged — government relies on revenue that is highly cyclical in nature to increase expenditure that is sticky and structural. Furthermore, the bias in government spending favours current expenditure (such as a large wage bill) at the expense of capital expenditure. This strong bias in expenditure in favour of consumption implies that government is channelling more resources away from investment and this ultimately becomes a drag on the potential growth of the economy. This lack of investment is further amplified by dysfunctional and struggling state-owned enterprises (SOEs).

Positively, however, we forecast a main budget deficit of 5.4% of GDP in 2021/22 versus the MTBPS at 6.6%. This also implies that SA could face a gross debt-to-GDP ratio of 68.7% in the current year, down from 69.9% projected in the MTBPS. Though this improvement in the fiscus compared with earlier expectations is positive, expenditure pressures remain large and the structural problems within the budget should keep optimism in the government bond market contained beyond the immediate headline numbers.

The main driver of the improved fiscal position comes on the back of conservative revenue forecast assumptions by the National Treasury at a time when commodity prices remain high. As a result, revenue growth continues to surprise on the upside. Specifically, the strong revenue overshoot is driven by corporate income taxes and, to a lesser extent, an overshoot of personal income taxes and VAT collection.

We believe corporate income tax revenue collection could be revised R58bn higher for 2021/22 relative to the MTBPS, while there could be a further R12.5bn upward revision to personal income tax collection and a R5.7bn rise in VAT collection relative to what was forecast before. This is money government did not expect less than six months ago.

The strong revenue performance implies that SA is unlikely to see new taxes or an increase in tax rates, apart from the usual adjustments for inflation where necessary, such as an inflation-adjustment in some excise duties and perhaps a marginal adjustment in the fuel levy (this adjustment, if any, would be small given the pressure that fuel prices are already putting on consumers).

However, the government is unlikely to use all this revenue windfall to embark on a path of fiscal consolidation that is much faster than what was envisaged in the MTBPS.  In fact, the National Treasury has already suggested that government would make sure fiscal consolidation is done in a growth-friendly manner. We read this statement as an indication that much of the revenue overshoot will be spent, rather than saved, to ensure fiscal policy doesn’t become an undue drag on economic growth.

For example, the president announced in his state of the nation address that the government will provide much needed additional social relief spending in the form of an extension of the social relief of distress grant for another 12 months. That will cost the fiscus R42bn in the next fiscal year — all of which can be paid by the revenue overshoot.

Worth noting is that this increased social relief spending is likely to become permanent in future years as it gets rolled up into some form of a more permanent basic income grant. But there are other spending pressures that range from the government wage bill to the usual SOE bailouts, which could add an additional R12bn to the 2022/23 expenditure estimate. While the IMF has recently suggested SA is considering the option to take on Eskom’s debt burden, we do not expect any firm announcement on this in the budget next week.

Ultimately, lower potential growth and sticky expenditure makes it even harder for government to respond to economic downturns or maintain a path of sustainable fiscal consolidation. On balance this favours a steady rise in the country’s debt stock over time, which comes with additional debt servicing costs. The MTBPS noted that debt servicing costs are estimated at R1-trillion over the medium-term expenditure framework and exceed all individual spending items by functions (apart from learning and culture) and are the fastest-growing expenditure component of the budget.

Therefore, reducing the debt-servicing cost via less debt, and by implication lower bond yields, can go a long way in alleviating SA’s infrastructure deficit. This unfortunately will only happen when the structural fault lines in growth and the budget are addressed. 

• De Wet is senior research strategist at Nedbank CIB Markets Research.