Budget preview: Call to courage
18 February 2016
Posted by: Author: Claire Bisseker
Author: Claire Bisseker (Financial Mail)
Expectations were high that President Jacob Zuma had grasped the severity of SA’s economic crisis and would use his state of the nation address (Sona) last week to announce game-changing reforms to stave off a credit rating downgrade.
Unfortunately, many commentators agree that though Zuma acknowledged the need to boost growth and avoid a rating downgrade, and that he ticked many of the right boxes on the economy, his speech fell short of these requirements.
Among the positive announcements were that government would cut bureaucratic excesses, remove red tape and review legislative implementation to ensure consistency and certainty, make it easier for companies to import skilled workers, keep the nuclear energy plan affordable and ensure a national minimum wage did not undermine small businesses or job creation.
But for government to regain credibility, evidence of a deeper, more heartfelt and irrevocable commitment to change was required than Zuma displayed.
"Overall, this barely met the grade for talking the talk, never mind showing that government is set to walk the walk,” says Rand Merchant Bank’s John Cairns.
Nedbank Capital’s Mohammed Nalla describes it as a speech which provided "more platitudes at a time when a much harder discourse was required from the president to restore confidence”.
Investors must hope that finance minister Pravin Gordhan, who has been assuring them that government will "do everything necessary to avoid a downgrade”, will present confidence-boosting measures in his budget, says Barclays Africa economist Peter Worthington.
The problem facing Gordhan is that growth has fallen way below treasury’s projections, reducing tax revenue at a time when borrowing costs have risen (due to the weak rand and rising bond yields) and inflation has pushed up the wage bill.
If the economy had been growing strongly Gordhan could have hiked taxes and slashed spending. But in a stagnant economy, where raising the growth rate is every bit as important as reducing the fiscal deficit, every move has to be carefully calibrated so as not to cause further harm.
Cutting infrastructure spending, for instance, would be an easy way to shore up the deficit, but must be rejected since doing so will undermine growth.
"I expect a very difficult budget for the minister,” says Stellenbosch University professor Stan du Plessis. "He must juggle the need for fiscal consolidation and the alarming slowdown in the economy. If he slams on the fiscal brakes too hard, the counterproductive impact on aggregate demand will make fiscal matters worse.”
And yet, Gordhan has little choice but to stick to SA’s fiscal targets if he is to avoid a further damaging slide in investor confidence.
"It will take a massive intervention just to preserve the fiscal deficit targets,” says Macquarie economist Elna Moolman. "There will need to be meaningful savings and outright, real expenditure cuts, not just to preserve our credit rating but also for the sake of fiscal stability, given how much money we are spending on servicing debt.”
Standard Bank estimates that for SA to stick to its target of reducing the deficit to 3% of GDP over three years, treasury will have to find an additional R30bn/year on average over this period. If it wants to better the target to 2.5%, it will need R50bn/year more.
To put this in perspective, a 5% cut in goods and services expenses would save around R10bn, according to Rand Merchant Bank. This is roughly equivalent to what could be raised in a year by hiking personal income tax rates by one percentage point.
Looking to the very rich to plug the gap is unrealistic. Some studies have shown that even if government instituted two new personal income tax brackets, including hiking the 41% marginal tax rate to 45% on income over R1m/year and taxing earnings over R2m/year at 50%, it would yield only R6.82bn more a year in tax revenue.
A one percentage point hike in the Vat rate would generate R20bn and is the closest thing to a silver bullet, but most commentators rule it out because of its regressive nature. In any event, people are already paying more for food because of the drought, and local government elections are looming.
Sanlam Investment Management economist Arthur Kamp expects broad-based tax increases. He estimates that if estate duty were to be doubled from 20% to 40% it would generate another R1,5bn. If capital gains tax was raised by 2.5 percentage points to 16% it would generate another R1.5bn, and for every percentage point increase in dividend tax, government could raise another R1.5bn.
Economists rule out the possibility of government raising the corporate tax rate, as to do so would, in theory, reduce business confidence and further harm the rate of private investment, thereby retarding growth.
But rumours abound that some business leaders have offered to accept such an increase in a grand bargain with government brokered in recent weeks. In return government is expected to expedite private sector partnerships, reform state-owned entities and take other pro-growth measures, many of which were agreed to by Zuma in the Sona.
Nevertheless, many economists remain unconvinced that the recent rapprochement between government and business is yielding results, and take the absence of bolder reform in the Sona as evidence of this.
For instance, Nomura’s Peter Attard Montalto points out that while Zuma said a report from the presidential review commission on parastatals would be implemented to improve financial sustainability, there was no mention of putting private sector management in place, which was a key suggestion from recent CEO meetings with the president.
"There were no shock-and-awe moments to show decisiveness, no pulling of rabbits out of a hat to show a different way of thinking, and no recognition that business-as-usual was insufficient,” he adds.
But others think the tide is turning. Standard Bank chief economist Goolam Ballim believes the national harm that a junk rating would cause has allowed practical voices with a reformist bent to gain the upper hand in the ANC. "There is just too much at stake for this to be mere spin and window dressing,” he argues.
Chamber of Mines CEO Roger Baxter agrees, saying: "Positive change is in the air”.
And Moolman insists that the stalemate between business and government has been broken. "The change is real,” she says. "There is a general acknowledgement in the ANC and business that we’re in a crisis and need to do things differently.”
Ballim says: "Any ambiguity in the Sona will be doused by the budget, in which Gordhan will give an unambiguous sense of where the political centre now resides and what has been yielded by the eruption of political forces in December.” He is referring to the axing of former finance minister Nhlanhla Nene.
But while Gordhan is likely to succeed in delivering fiscal conservatism, it will take enormous charisma for him to reignite confidence and growth simultaneously, given Zuma’s failure to champion a change of course more convincingly.
If Gordhan fails, the risk remains high that SA’s credit rating will be cut to junk by one or more agencies some time this year, trapping SA in a low-growth stalemate for years to come.
This article first appeared on financialmail.co.za.