Mini-budget: Tito’s first test of boldness
Holding the line on spending at the medium-term budget review will be Mboweni’s first test as finance minister
Any gloom about the upcoming mini-budget is overdone. Thanks to buoyant inflation, nominal GDP is outperforming expectations, as are VAT receipts. This should allow SA to escape its medium-term budget review with minor fiscal slippage and its credit rating intact.
When the economy sank into a recession in the second quarter, economists warned that downward pressure on SA’s credit ratings would once again start to build.
Though the pressure is indeed increasing — and real problems lie down the line, should SA fail to stage a meaningful economic recovery over the next few years — the country is not going to be tipped over the fiscal cliff at the October 24 medium-term budget review, now being delivered by newly appointed finance minister Tito Mboweni.
The budget numbers are likely to hold up well for several reasons.
First, it would be odd if the National Treasury doesn’t err on the side of optimism when it comes to its growth and investment forecasts, given that it has to show some faith that President Cyril Ramaphosa’s fiscal stimulus package, the jobs summit commitments and the imminent investment summit will bear fruit.
Second, nominal GDP has held up well thanks to a pick-up in inflation, and revenue growth has remained buoyant thanks to higher-than-expected VAT collections.
With just five months of data available for the 2018/2019 fiscal year (April to August), it’s still a bit too early to say whether SA’s fiscal consolidation plan is on track. But so far the numbers are reasonable.
Despite the economy entering a recession in the second quarter, nominal GDP is running at 7.5% for the fiscal year to date, compared with the Treasury’s forecast for a 6.9% increase. This is because inflation climbed to 7.1% in the second quarter, compared with the 5.4% budgeted for.
"They were saved by the rise in inflation," says Sanlam Investment Management economist Arthur Kamp. "This was lucky but, of course, it’s bad for SA’s long-term growth potential to have lower real GDP growth and higher inflation. SA needs GDP growth to lift significantly into next year, and keep it climbing."
He estimates that if nominal GDP growth remains robust, the main budget revenue shortfall shouldn’t be much bigger than about 0.2% of GDP or R9.5bn for the year (assuming the expenditure target is met). Such a small shortfall shouldn’t alter the debt ratio significantly. It is also unlikely to provoke immediate approbation from the ratings agencies.
Citibank economist Gina Schoeman expects the Treasury to budget for real GDP growth of about 1% this year, down from 1.5% in February but ahead of the consensus expectation of 0.8%. She thinks any fiscal slippage will likely be contained to about 0.2 percentage points, widening the 2018/2019 consolidated budget deficit from 3.6% of GDP to about 3.8%.
But to demonstrate that real consolidation is still on the cards, the Treasury will have to budget to reduce that ratio to below 3.8% by 2020/2021.
For the fiscal consolidation path to remain credible, the medium-term budget will have to demonstrate how Ramaphosa’s new fiscal stimulus plan and job-summit commitments are going to be funded, without breaching the expenditure ceiling.
He has promised to centralise R400bn spending on infrastructure in the presidency and to free up a further R50bn for more productive expenditure through reprioritisation. In addition, the R30bn public-wage settlement overrun must be accommodated without any forced retrenchments.
"It would be a good thing if the R50bn goes to infrastructure," says Kamp. However, he points out that a successful fiscal consolidation plan would involve cutting expenditure, not just sticking to the expenditure ceiling, which allows expenditure to keep growing in excess of inflation.
Because of this, SA needs a significant growth upswing to materialise over the next two years if it is to meet its debt-reduction targets and return to a path of fiscal sustainability.
Turning back to the current fiscal year, expenditure is growing slightly slower than expected while revenue growth is running slightly ahead of target at 11.2% for the fiscal year to date. The SA Revenue Service (Sars) collection target is R1.3-trillion, up 10.3% from the previous financial year.
Though personal income tax growth is bang on target at just under 10%, corporate income tax receipts have increased by only 2.8% this fiscal year against the 6.4% budgeted for. This is in line with the weak gross operating surplus data coming out of the corporate sector.
Long-term fiscal sustainability will remain elusive unless SA enjoys a continued business cycle upswing and real interest rates remain low. Both are unrealistic assumptions
On the other hand, VAT receipts are up almost 20% against expectations of 14.8% growth.
Given how unpopular the VAT hike was, it will be important for the Treasury to provide feedback on the effect this has had on revenue collection and whether relief can be provided in line with the Woolard Panel’s recommendations to zero-rate additional items, says Mazars head of taxation Mike Teuchert.
There is also intense pressure on the government to provide relief from rising fuel prices. According to energy minister Jeff Radebe, the government is considering fixing a maximum price for unleaded petrol to cushion the country from escalating prices.
Given that such a move cost R400m in the month of September alone, refusing such a proposal — and other appeals for additional funds for, say, national health insurance (NHI) or free higher education, from a president who is facing an imminent election — is likely to be Mboweni’s first test as finance minister.
Economists are hopeful that Mboweni will have the backbone to stand up for the fiscus because he understands that loosening the fiscal reins could well result in a Moody’s downgrade and much higher borrowing costs, which would be entirely self-defeating.
The backlash against the fuel tax and VAT hikes also means there is little room to keep hiking taxes to accommodate higher expenditure. It is, for instance, going to be very difficult for the government to hike VAT again to fund NHI, something that has always been the Treasury’s backstop plan.
For Schoeman, a big question mark remains over the Treasury’s assumption that tax buoyancy will pick up to 1.5 this year (which means that for every 1% rise in GDP, tax revenue rises by 1.5%). The ratio has been running at only about 1 over the past year.
She will also be looking to see whether the mini-budget assumptions take account of the 1.3-million drop in assessed taxpayers since 2013. The probable causes include tax evasion, emigration and rising unemployment.
"If SA is experiencing an increase in tax avoidance then it might offset the increase in the VAT rate and it would be prudent for the Treasury to start assuming a tax buoyancy figure below 1, rather than to keep assuming it will hold to the pattern of the past 10 years," she warns.
What it means
Fiscal slippage is likely to be contained, but growth must pick up
On the other hand, Teuchert points out that Sars has put significant effort into increasing its collection efficiency, including re-establishing its Large Business Centre and collaborating with the tobacco sector to combat the illegal cigarette trade. It is also considering the introduction of administrative penalties on outstanding corporate income tax.
While the possibility remains that fixed investment could take off on the back of Ramaphosa’s investment drive (some big deals are likely to be announced at the investment summit on October 25-27) little in the data suggests that a pick-up in growth is imminent.
But even assuming real GDP growth manages to hit 2% over the medium term, long-term fiscal sustainability will remain elusive unless SA enjoys a continued business cycle upswing and real interest rates remain low.
Both are unrealistic assumptions given that the global recovery is becoming long in the tooth and that monetary policy is normalising in both the US and Europe after a decade of ultra-low interest rates.
For some time, the government’s financing costs have exceeded GDP growth in both nominal and real terms.
The real interest rate on SA’s existing debt is manageable for now at about 1.5%. But the real interest rate on long-term, noninflation-linked new debt at 3%-plus is too high even if SA is growing at 2%.
In short, if growth does not recover sustainably above 2% over the longer term, SA will be in an increasingly difficult fiscal position and under renewed ratings-agency pressure.