How mini-budget austerity will hit you
09 October 2015
Posted by: Author: Claire Bisseker
Author: Claire Bisseker (Financial Mail)
Over the next few years, sluggish growth is likely to undermine revenue collection and compromise SA’s fiscal targets. How finance minister Nhlanhla Nene responds on October 21, when he presents his mini-budget, will largely determine whether SA’s sovereign credit rating is cut again this year.
National treasury’s success in holding expenditure to a ceiling over the past few years and complementing this with tax increases in the current budget has helped to ease some of the ratings agencies’ concerns over SA’s fiscal sustainability.
However, the prospect of low, stagnant growth for the next few years raises fresh concerns that revenue will undershoot and debt will fail to stabilise.
SA’s February 2015 national budget forecast that the deficit would shrink to 2,5% of GDP by 2017/2018 and that gross loan debt would peak at 47,6% of GDP in the same year.
Last month, Moody’s expressed confidence in treasury’s ability to get the debt ratio to stabilise below 50%. But it warned that SA’s rating could be cut if its commitment to debt stabilisation faltered, the investment climate deteriorated further or there was a significant rise in contingent liabilities (such as could be caused by Eskom and other state-owned enterprises).
Nene’s problem is that meeting his fiscal targets relies on real GDP growth recovering to 2,0% in 2015, 2,4% in 2016 and 3,0% in 2017. He will now have to revise this down closer to the Reserve Bank’s latest growth forecast of 1,5%, 1,6% and 2,1% respectively.
The deterioration in the growth outlook means that less tax revenue will be collected than expected, says Investec chief economist Annabel Bishop. Unless government responds with higher taxes and/or greater expenditure restraint, it will fail to stick to its debt and budget deficit reduction path, lifting the borrowing trajectory and thereby reducing SA’s perceived creditworthiness.
In previous years, government’s contingency reserve of unallocated funds (its rainy-day kitty) has provided some room in the budget. Over the next three years, however, the contingency reserve will be entirely wiped out by the R66bn overrun in the wage bill caused by the outsized pay agreement struck with public sector unions in May.
Continued sluggish growth is a significant risk to government’s medium-term fiscal targets, warns HSBC’s SA economist, David Faulkner. He estimates that SA is headed for a total revenue shortfall of R48bn over the next three years.
This is based on his assumption that SA’s growth rate will remain below 2% over the medium term at 1,4% this year, 1,6% next year and 1,9% in 2017. This is only just below the Reserve Bank’s forecast.
Consequently Faulkner expects SA’s consolidated budget deficit to come in at 3,8% in 2015/2016 (compared to Nene’s target of 3,9%), 3,1% of GDP in 2016/2017 (versus a target of 2,6%) and 3,0% in 2017 (versus 2,5%).
This translates into a revenue shortfall of about R7bn in 2015/2016, rising to R19bn in 2016/2017, rising to R22bn in 2017/2018 — R48bn in total.
"There are significant downside risks in the years ahead," says Faulkner, "especially if the deceleration we’ve already seen in the growth rates of major tax revenue bases (employee compensation, corporate profits and household consumption) persists, compromising government’s tax targets."
Surprisingly, Faulkner expects the budget outcome in the current fiscal year to exceed expectations, despite a projected R7bn revenue shortfall.
There are two main reasons for this. First, the proposed one-off relief for Unemployment Insurance Fund contributions — which would have put R15bn back into the pockets of workers and businesses — was not implemented. This will boost consolidated government revenue by about 0,4% of GDP.
Second, tax revenues are so far holding up surprisingly well. However, Faulkner notes that this masks disparate tax performance, with robust personal income tax and fuel levy growth offsetting weakness in corporate taxes, customs duties and domestic Vat (see graph).
"There is still the risk that slow growth means revenues perform even worse than we expect in the second half of the year, putting upward pressure on the budget deficit," he warns.
But even then, Faulkner expects treasury to counteract any revenue slippage using last year’s overrun of R9bn-R10bn. The successful take-up of the noncompetitive portion of government bond auctions also means debt raised in the current year will exceed budget estimates.
The more serious problem is what Nene will do about years two and three of the medium-term fiscal framework.
The situation calls for further belt-tightening, which will have to come through higher taxes and/or lower spending. The danger is that Nene will fail to respond strongly enough and once again prove too optimistic in his growth forecasts.
Bishop is expecting "an austerity budget of higher taxes and some expenditure cuts".
Her money is on another 1% increase in personal income tax rates, potentially again around the R181 000/year mark, given that there are too few wealthy citizens to generate sufficient revenue should increases be levied only at higher thresholds.
A Vat hike also seems possible, given the finding of the Davis Tax Committee that a hike in Vat would be less harmful to GDP growth and employment than a rise in either personal or corporate tax.
Treasury has estimated that a 3% rise in the Vat rate would generate R45bn. To get the same amount through direct tax increases, personal income tax would have to be raised by 6,1% and corporate tax by 5,2%.
However, Bishop argues that instead of hiking taxes, which will merely slow economic growth further and result in a negative downward cycle, government should look to cut expenditure outright — not just slow the real growth in expenditure.
She notes that Fitch has become increasingly negative about SA’s economic growth outlook and perceived credit worthiness this year. She expects Fitch to downgrade SA’s foreign currency long-term rating in early December to BBB-, bringing its rating in line with Standard & Poor’s, which already has SA on the last rung of the investment grade ladder.
Faulkner agrees that fiscal tightening could weigh on an already weak growth outlook, but says government will have to balance these concerns with the risks that would be attached to allowing SA’s fiscal metrics to continue to deteriorate.
This article first appeared on financialmail.co.za.