Picture: GCIS
Picture: GCIS

The 2018 budget has snatched SA from the jaws of a debt trap, almost certainly averted an imminent credit rating downgrade from Moody’s and cemented the foundations of the country’s newly established economic recovery.

The bad news is that all taxpayers will pay for the profligacy of the Zuma years through higher taxes, including a hike in Vat to 15%. But the good news is that the reduction in fiscal risk should fuel confidence and, hopefully, growth.

"This is a tough but hopeful budget," said finance minister Malusi Gigaba in his speech. "Acting now to strengthen the fiscal position will improve the outlook for the economy and increase space for future investment growth."

The first order of business was to correct the impression created by his medium-term budget in October that government had relinquished its commitment to fiscal discipline.

Instead, the 2018 budget accelerates fiscal consolidation, while accommodating a promised rollout of free higher education over the next three years with a whopping R57bn allocation.

Thanks to expectations of higher GDP growth, a stronger currency, lower borrowing rate and significant fiscal consolidation, the deficit-to-GDP ratio will fall to 3.5% in 2020/2021. Before, it was expected to remain just under 4% over the medium term.

The upshot is that gross government debt will stabilise at 56.2% of GDP in 2021/2022 instead of blowing out to 60% as forecast last October. It’s a big improvement, even though it will take almost five years for debt to stabilise.

For this, SA will get a big tick from the markets and rating agencies. The rand strengthened by 10c to R11.62/$ during Gigaba’s speech.

"In light of the political flux [this budget] was produced in, it is excellent," says Investec’s Nazmeera Moola. "By raising Vat, government has indicated a willingness to take difficult and unpopular decisions to stabilise the fiscus. Coupled with the recent change [of] president, this budget should be enough to keep Moody’s on hold when it releases its SA sovereign review on March 22," she says.

In the next few days, new president Cyril Ramaphosa is expected to announce a new cabinet. If his choices are solid, it may even be enough for Moody’s to move SA’s rating outlook to stable from negative, Moola feels.

Taxpayers can be forgiven for being less than enthusiastic, however, given that the new tax measures will push SA’s gross tax-to-GDP ratio from 25.9% now to 27.2% in 2020/2021 — among the top 10 highest ratios in the world.

The challenge for government in slowing debt was to be mindful of the constitutional imperative to address SA’s vast service-delivery needs and protect the poor.

This was a tall order, given the R48bn revenue shortfall in the current financial year, coupled with the last-minute Jacob Zuma-led directive to fund free higher education.

"Something had to give," explained Gigaba.

The result: painful fiscal measures, including tax hikes of R36bn in 2018/2019 and spending cuts of R85.7bn over the next three years.

Treasury has been forced to make difficult trade-offs in determining which taxes to raise in a fragile growth environment and where to cut government spending to minimise the impact on service delivery.

The danger was that if it cut too much, or hiked taxes in the wrong place, SA’s growth recovery could have been scuppered. But the loss of investor confidence, had public finances not returned to a more sustainable path, could have been far worse.

Higher-income earners will bear the brunt of the tax increases. Estate duty will climb from 20% to 25% for the wealthy, excise duty on cars will go up from 20% to 30%, medical tax credits will be eroded, and the top four tax brackets will get zero relief from fiscal drag.

But the Vat hike was the real clincher. Until now, the ANC government has rejected a Vat hike, arguing it is a regressive tax that hurts the poor the most. But with SA’s options so limited, there weren’t too many other levers to pull.

In recent years, the tax measures have focused mainly on personal income tax (PIT). But its PIT revenues have disappointed recently, coming in R21bn short of the 2017/2018 target. This suggests further increases might not have yielded the required revenue. Also, extra PIT hikes would have had greater negative consequences for growth and investment than a Vat increase, the Davis Tax Committee found.

It was the same story with corporate income tax (CIT). At 28%, SA’s CIT rate is becoming a global outlier — threatening the country’s competitiveness and providing an incentive for companies to shift profits abroad. The US, for example, has cut its corporate tax rate from 35% to 21% and the Netherlands from 26% to 21%.

This left Vat, which will bring in R22.9bn of the R36bn in extra tax revenue in the next year.

To cushion the impact on the poor, social grants will be increased by more than inflation. Gigaba said free higher education and a new national minimum wage will also help.

During a pre-budget briefing, he admitted that while tax increases would "cause economic discomfort", the impact of fiscal consolidation on growth and service delivery would be "bearable". And it was necessary to protect the integrity of SA’s public finances.

Tax hikes aside, the budget capitalises on the "renewed sense of optimism" sweeping SA.

For one thing, the growth outlook has improved since October, because confidence has risen thanks to greater political certainty.

The SA Chamber of Commerce & Industry confidence index has reached its highest level since October 2015, while the Absa purchasing managers’ index is at its highest level since January 2010. More private investment should follow.

Critically, treasury is now expecting real GDP to amount to 1.5% this year (previously 1.2%) rising to 2.1% by 2020. This is roughly in line with the wider economic consensus, but Gigaba is "very optimistic" that this could be exceeded if the Ramaphosa-led government is able to maintain its reform momentum.

In a best-case growth scenario, treasury forecasts that if government is able to institute robust structural reforms, including to state-owned enterprises (SOEs), and bolster confidence and investment, then real GDP growth could top 2% this year.

If the global economy continues to play ball.

Treasury says if government can finalise reforms in just four key sectors, SA’s potential growth rate could be raised from 1.5% to over 3.5% over the next decade (see graph).

These reforms are: implementing mining-sector policies that support investment and transformation; releasing extra broadband spectrum; lowering barriers to entry for business by addressing anticompetitive practices; and providing support for labour-intensive sectors like tourism and agriculture.

"Ultimately, all our budget woes would be resolved if we could get growth going," says Moola. She estimates that if SA could get growth of 3% by 2020, this alone would move the budget deficit to 3.4% of GDP.

On spending, R85.7bn will be cut over the next three years. However, because of the huge outlay for higher education, the pace of government spending will still average 2.1% of GDP in real terms, reaching R1,9trillion in 2020/2021. Higher education now becomes the fastest-growing spending item, at 13.7%/year, over the medium term — exceeding growth in state debt costs (which is 9.4%) for the first time.

The largest category of spending remains salaries for government employees, which accounts for over 35% of expenditure. This is followed by basic education (16.5%) and health (13.9%). Unfortunately, this means the composition of spending will shift from capital towards consumption spending — something which treasury acknowledges is the very opposite of the adjustment required.

On the other hand, there is still room for more savings if Ramaphosa merges some departments and slashes his cabinet.

The public-sector wage settlement, being negotiated now, will be critical. Any deviation from the budgeted increase of 7%/year will derail plans — not for the first time either.

About 60% (R53bn) of the R85bn in spending cuts will come from national government — including from defence, prisons, and trade & industry.

Infrastructure grants to provincial and local governments have also been cut, by R28bn. This will slow school building programmes (a R3.6bn cut) and the provision of new houses and serviced sites (a R7.2bn cut), but these are areas with a history of hefty underspending anyway.

However, government has taken care to protect services — including school meals, bus subsidies and medicine. Also, R6bn has been provisionally allocated to drought management. The potential for a severe contraction in the Western Cape economy due to drought is flagged as a risk in the Budget Review.

Other fiscal risks include continued policy and political uncertainty, wage pressure, and the fact that large parts of the public-sector balance sheet have become "exhausted" at a time when the full costs of free higher education and National Health Insurance (NHI) are uncertain.

Budget officials say treasury considered raising Vat by two percentage points, but held off as it was able to make up the extra revenue needed by raising a variety of other taxes. But this doesn’t mean further Vat hikes can be ruled out.

And if government wants full-scale NHI, another Vat hike seems the only viable option. "If you’re going to have step changes in spending, you’re going to need another big bullet," said one government official in a pre-budget briefing. "Government needs to stabilise expenditure. It can’t keep having step changes every year."

The main risk to SA’s public finances remains the parlous state of finances at just about all the state-owned enterprises.

Thankfully, decisive action by government to strengthen governance at Eskom has staved off the likelihood of a near-term default. But the financial position of the power utility, as well as several other beleaguered state companies, poses big risks to the economy and the fiscus.

"SOEs are in large measure fiscally unsustainable," Gigaba conceded in a pre-budget briefing. But he vowed that robust turnaround plans would be implemented

For a start, a new government guarantee and funding framework for state companies is in the final stages of being revised. Arms company Denel is next in line for a new board, Gigaba said.

Importantly, Gigaba also promised that any spending on state companies would be done in a "deficit-neutral" manner — in other words, in ways that won’t add to government debt. Most likely this will be done through introducing strategic equity partners, as well as direct capital injections and selling noncore state assets.

In this last category, government’s property portfolio is the immediate low-hanging fruit. Already, treasury has identified 195,000 state properties in prime locations, with an estimated value of over R40bn.

Selling non-core assets will help plug some holes in the dyke, but can never provide a lasting solution.

North-West University professor Raymond Parsons says the danger of SA drifting into a negative tax-and-spend cycle can, however, be averted if strenuous efforts are made to slash the size of government and boost growth.

"Unless fundamental economic reforms are in the offing, and if the economy languishes in a low-growth trap, the balancing of the books in the 2018/2019 budget will rest on weak foundations," he says.

Ramaphosa, and whoever is sitting in the chair of the finance minister in the next few months, will be keenly aware of this fact.