Pressure is on Gigaba to show he can deliver on Davos debt promise
Ettienne le Roux: The finance minister has little choice but to show his resolve by reducing the budget deficit, but how will he plug the holes?
A month ago, Team SA, under the leadership of newly elected ANC president Cyril Ramaphosa, attended the World Economic Forum in Davos. In their investor-wooing sales pitch, several policy changes were mooted, chief among them Finance Minister Malusi Gigaba’s undertaking to get the government’s finances back on a sustainable track.
But will he succeed? The answer will be clear after he has delivered the 2018 budget on Wednesday. The scale of the challenge is clear when considering the recent sharp worsening of the government’s debt profile and the extent of the action necessary to improve the trend. In recent years, the combined impact on the fiscus of low economic growth, deteriorating tax collection and persistent rapid increases in current expenditure has been significant.
As the budget deficits have continuously disappointed, with new borrowings having soared as a result, the government has become more indebted: in the past year alone, its projected debt-to-GDP ratio has jumped from an initial peak of 53% in 2018-19 to one that now rises beyond 60% in future, and this excludes the recent surge in debt guarantees to state-owned enterprises (SOEs).
The cash flow implications of all this have been severe. Only five years ago the government needed R90bn per annum to service its debt load. That figure has doubled now. But the fact that the interest bill already absorbs 14% of the main budget revenue — high compared with other emerging economies — is not the only concern.
Also worrying is the rate at which it is crowding out economic and social priorities. State debt costs already exceed the government’s annual capex budget and at the going rate will almost equal what the government plans to spend on health by 2020-21.
But stabilising the debt load somewhere below its current projected path, as the minister intends to do, will take some doing. He cannot rely on a sudden spurt in economic growth to boost tax revenue. While the recent political change will lift consumer and business confidence, it will take time before this translates into higher spending and fixed investment. In addition, there is the prospect of further private sector headcount reductions (the jobs market lags the business cycle), the stronger rand hurting export growth and the drought in the Western Cape affecting agriculture and tourism.
Notable problems at the South African Revenue Service mean tax administration challenges are likely to linger. For the Treasury to expect the tax-buoyancy rate (the relationship between GDP growth and tax collections) to suddenly bounce back is unrealistic.
The finance minister has little choice but to show his resolve by reducing the budget deficit. So, what will it take to lower the debt projection to, say, 57% of GDP — an outcome we think would be sufficient to keep Moody’s at bay and save South Africa from exclusion from key global bond indices and the forced selling of government bonds — and keep it there?
To have the desired outcome and even before considering the possible cost implications of free tertiary education, our estimates show the Treasury must slash its original budget deficit forecasts by about 1% per annum, to average about 3% of GDP. Such a reduction is small in percentage terms but eye-popping in rand terms.
In the absence of a notable recovery in growth and tax collection, the required tightening amounts to about R50bn each year, starting with the budget year ahead. This is on top of the R68bn of tax hikes and spending cuts (R53bn in 2018-19 and R15bn in 2019-20), which that were incorporated in the 2017 budgeting process.
The enormity of the task at hand is even clearer when the necessary narrowing in the deficit is seen in the context of all the tax adjustments announced in the 2017 budget. The combination of minimal fiscal drag adjustments, a higher top marginal personal income tax rate of 45%, the dividend withholding tax rising from 15% to 20% and sharp increases in a variety of indirect taxes brought in only R28bn for 2017-18.
The need for complementary new tax and spending initiatives is clear. There is limited scope to further raise personal income tax rates (PAYE already accounts for 38% of the gross tax revenue, a 20-year high) or to hike the company tax rate (global trends are towards lower rates). This essentially leaves a broadening in the value-added tax (VAT) base, hiking the VAT rate, partially scrapping medical tax credits and again just making small fiscal drag adjustments as the only means available to help plug the big holes.
Hiking tax rates aggressively when growth in real income per capita is negative and tax morality has worsened could have undesirable side-effects. He will also have to enforce even greater spending discipline.
While the stronger rand (and possible rate cuts) will help lower interest payments on debt denominated in foreign and local currency, the real savings will only come from restraining the growth in wage costs and operating expenses. Combined, the government’s annual wage bill and running expenses amount to R770bn. Reducing the average annual projected growth rate of 7.2% by just half a percentage point and leaving the nominal rate comfortably exceeding expected inflation will reduce the budget deficit by nearly R30bn over the next three years.
Much must also be done to further cut wasteful and irregular spending.
The budget is the ideal platform for Gigaba to act on the intentions expressed at Davos. On this score, he has some particularly difficult choices to make to shift public finances back towards sustainability. While the detail behind a noteworthy reduction in the budget deficit would not be a pleasant message to deliver, it must be done. Yet a tightening in fiscal policy will take pressure off the budget in the immediate term only.
To solve the root cause of the country’s fiscal problems, namely low GDP growth, it is critical that his debt-stabilisation strategy be accompanied by a better-articulated plan to tackle the factors that continue to constrain economic activity. These include persistent policy uncertainty around mining, telecommunications and land reform, as well as the severe financial problems at SOEs.
• Le Roux is chief economist at Rand Merchant Bank