Overall impressions
- Much weaker fiscal picture than previously expected over medium-term expenditure framework (MTEF) between FY19/20 and FY21/22 relative to February 2019 budget projections, budget-deficit-to-gross domestic product (GDP) is on average 2% wider and R99 billion higher in each year deficit staying above 6% of GDP up to FY22/23 è primary budget balance (excluding interest payments) remains in deficit in MTEF period
- Fiscal slippage is driven by weaker revenue projections (down R77 billion on average each year versus February 2019) linked to a smaller and weaker economy and poor SARS collections, coupled with higher spending (up R22 billion each year on average versus February 2019) due to a R161 billion Eskom bailout in the period
Immediate market effect
- Budget cannot be regarded as fiscally prudent high deficits, expenditure growth outpacing revenue growth by 3½% on average initially and a rising debt ratio should be negative for bonds and the currency
Fiscal and debt targets missed by far
- Main budget deficit to swell to 6.2% of GDP in FY19/20 (previously 4.7%), 6.8% in FY20/21 (previously 4.5%) before narrowing slightly to 6.5% in FY21/22 (previously 4.5%) and to 6.2% by FY22/23
- Slower deficit reduction relative to Treasury’s February 2019 projection is largely related to a materialisation in downside risks to growth and revenue forecasts and an upward revision to expenditure due to financial support for Eskom
- Acute fiscal deterioration has torpedoed the possibility of debt stabilisation debt ratios rise throughout the MTEF period è gross debt-to-GDP expected to rise from 56.7% in FY18/19 to 71.3% in FY22/23 and 81% by FY27/28
Both spending cuts and higher taxes needed in future to address huge fiscal slippage
- Government’s economic assumptions on growth (1.4% on average for FY19-22) and inflation (4.7% on average) that drive their revenue projections in coming years are similar to those of Momentum Investments, while its downwardly-revised tax buoyancy (revenue per unit of GDP) forecasts also look realistic
- Tax burden (tax-to-GDP ratio) set to remain close to 26% throughout the MTEF period (FY19-22)
- The flat tax-to GDP ratio, the large tax shortfalls despite additional taxes and the poor tax buoyancy in recent and coming years could indicate that SA is close to the inflection point on its Laffer curve so that higher tax rates in future are unlikely to generate much higher tax revenues
- Although there seems to be acknowledgement from government that future fiscal improvement will have to be driven by spending restraint, particularly on the public sector wage bill, the difficulty of discussions with labour on the latter and the magnitude of the fiscal problem mean that future tax increases are contemplated
- Revenue collection in MTEF disappoints on implosion of growth and SARS
- During the last 5 years there has been an exponential rise in tax shortfalls every year as the economy and SARS imploded è this trend is expected to continue in the MTEF è the tax shortfall is estimated at R53 billion for FY19/20 (previously R15.4 billion) and R84 billion and R115 billion in the following two years
- Lagging tax collections is widespread across every single revenue grouping most worrying is the underperformance in the big revenue categories of personal income tax, VAT and corporate tax
Cuts to expenditure, but Eskom refinancing causes strong spending growth
- Although spending reductions of R50 billion over the next two years is budgeted for, financial support for Eskom overrides this, causing overall spending to still rise by 11.7% and 7% in the period, respectively it also needs to be carefully monitored that the mooted spending cuts will be on current spending and not on capital spending that could hurt growth down the line
- Civil servants by far continue to consume the largest part of the expenditure cake 34% of total options considered to rein in the public sector wage bill are salary increases at or below inflation, halting pay progression and reviewing occupation-specific dispensation for wages but ominously government mentioned that they will first have to discuss these options with labour for buy-in, which may be unattainable
Moody’s could downgrade SA’s credit rating outlook on fiscal slippage
- The rapid fiscal deterioration projected in the MTEF that causes SA’s debt ratio to continually drift higher in the medium term could entice Moody’s rating agency to now seriously consider moving the country’s credit rating outlook from stable to negative, followed by a rating downgrade to junk later in 2020 or in 2021 if no fiscal recourse is evident by then
- A ratings downgrade could be averted if the February 2020 budget provides clear evidence that government is adhering to its newly-announced fiscal target of a primary balance (excluding Eskom financing and interest expenditure) by FY22/23 through cutting the public wage bill and instituting additional tax measures
- Moody’s already includes Eskom’s government-guaranteed debt under the country’s debt è hence there should not really be a negative impact on the rating from any future government move to take Eskom’s debt onto its balance sheet
Herman van Papendorp is head of investment Research & Asset Allocation at Momentum Investments.