There is little Treasury can do to avoid further deterioration in budget deficit
SA’s fiscal challenges are underpinned by a downward trend in revenue collection and an over-reliance on borrowing
Finance minister Tito Mboweni is set to deliver the 2019 budget on Wednesday against the backdrop of an economy characterised by prolonged underperformance and a social context underscored by growing discontent. These are likely to be exacerbated by the increased risks in the global environment — slower growth, Brexit, trade tension and climate change.
Combined, these factors have manifested in acute challenges that threaten to undermine the current path of fiscal consolidation and, by implication, the broader economy. It necessitates a change in direction. As such, politically difficult choices appear unavoidable, even in the run-up to a general election.
Business Unity SA has identified three of the most pressing themes that should form part of the budget: addressing the urgent governance, financial and operational challenges in state-owned entities (SOEs), in particular Eskom; declining tax revenue; and pursuing pro-growth policies. The latter emerged during Mboweni’s maiden medium-term budget policy statement (MTBPS) in October 2018 and should be reinforced in the budget, as adopting a pro-growth strategy is a viable means of climbing out of the current fiscal challenges and constraints.
SA’s fiscal challenges are underpinned by a downward trend in revenue collection and an over-reliance on borrowing.
Busa has consistently argued that chronically underperforming and costly SOEs probably pose one of the greatest risks to SA’s public finances. The qualified audits of a number of SOEs and, even more concerning, the failure in some cases to submit annual reports on time point to governance challenges.
Eskom is the most pressing case because of its role as the mainstay of the economy: without a reliable power supply, the wheels of economic activity grind to a halt. The power utility’s reintroduction of rotational load-shedding has brought its broader problems – operational, structural and financial – into stark relief, as has the admission by public enterprises minister Pravin Gordhan that Eskom is in crisis.
President Cyril Ramaphosa’s announcement in the state of the nation address (sona) two weeks ago, that Eskom will be divided into three separate entities for generation, transmission and distribution is an indication that further delays in reform can no longer be supported. The current severe operational challenges experienced by Eskom, its R420bn (and rising) debt and inability to enforce payment by errant customers threaten to derail the progress made at the Jobs Summit and 2018 Investment Conference.
The budget is expected to provide details on the nature of any fiscal relief to Eskom which, according to Ramaphosa, will be contingent on a detailed turnaround strategy. Unlike previous strategies, there exists no further fiscal space for anything short of stringent reforms to tackle the difficult challenges of overstaffing, debt collection, procurement reform and addressing a skills deficit. At some point, and the budget may give some pointers towards this, the partial privatisation of Eskom’s generating capacity would introduce much-needed competition and efficiency, as well as welcome fiscal relief over the medium to long term.
Given current fiscal constraints, the only obvious way of resolving the financial challenges faced by SOEs is in a fiscally neutral or positive manner. This would imply bringing in outside finance and partners where possible through the partial or full privatisation of SOEs, or indeed the outright disposal of non-core, non-strategic assets by the state. Furthermore, closing non-essential SOEs cannot be ruled out.
One of Mboweni’s positive messages emanating from the MTBPS was the indication that no further tax increases were envisaged over the medium term. This reflected the fact that, despite the growing gap between revenue collection and expenditure, further hikes would be self-defeating. Worryingly, the MTBPS outlined a decline in the tax buoyancy ratio to 0.91, underscoring that the economy is indeed at a point where further tax increases are counter-productive.
We, therefore, expect no major changes to tax policy in this Budget. However, there might be a temptation to extract revenue wherever possible. In a context of slowing receipts for corporate income tax and personal income tax – for a projected total of R10bn below MTBPS estimates — as well as the recent and politically difficult increase in value-added tax, underperformance in revenue collection is likely to be compensated by limited fiscal drag relief for higher-income earners and increases in so-called “sin” taxes.
On the latter, any excise increases need to be balanced against the negative impact on the competitiveness of legitimate goods vis-à-vis illicit goods and trade. Over the medium-term, a more stringent and effective crackdown on the illicit economy holds a greater prospect of increasing revenue.
Towards a pro-growth policy direction
Given the political improbability of significantly reducing expenditure targets, depressed revenue collection and some form of fiscal support for Eskom and other SOEs, an increase in the budget deficit is expected.
As with recent Budgets, the only sustainable route to current fiscal consolidation resides in inclusive economic growth. Over the long term, per capita growth hinges on structural changes which must, however, begin with a pro-growth policy direction to unlock private sector investment. With inadequate fiscal space for outright stimulus, the key objective for this year’s Budget must be to achieve a credible change in narrative insofar as SA’s policy direction is concerned.
The balancing act that the Budget needs to achieve is to begin a focused national dialogue on the size of the state that SA can sustainably maintain, and the related question of the respective roles of the public and private sectors.
The budget will need to outline in far greater detail the government’s commitment to a growth-friendly regulatory environment. Foremost among this will be to assure investors of the country’s continued commitment to property rights, in the context of the discussion around expropriation without compensation, as well as to the independence of the Reserve Bank and the retention of inflation targeting. Addressing the public sector wage bill and SOE reform is also important.
In the immediate future, there appears little that Treasury can achieve to avoid further deterioration in the budget deficit, and the associated responses by sovereign credit ratings agencies, including Moody’s Investors Service. Unfortunately, the reforms required to create the conditions for sustained improvement are not short term in nature. The urgent task of this year’s budget is, therefore, one of continuing the growth-friendly messaging from the MTBPS and demonstrating the required intent and commitment in creating and implementing the conditions for inclusive economic growth.
• Busa executive director for economic policy Olivier Serrao.