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What’s holding back SA’s economy?

24 February 2016   (0 Comments)
Posted by: Author: David Maynier
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Author: David Maynier (IOL)

On February 11, President Jacob Zuma delivered his State of the Nation Address in Parliament. He acknowledged that the economy was in trouble and that it was time to "do things differently”. However, there was no decisive response to the economic crisis and the risk of a sovereign ratings downgrade in South Africa.

The Minister of Finance, Pravin Gordhan, will now take the baton when he tables the Budget in Parliament today.

However, the minister is in a tight spot, with very little fiscal space, and even less political space, available to respond to the economic crisis and the risk of a sovereign ratings downgrade.

Read: Will Gordhan's budget appease investors?

The economic outlook this year is dire: growth projections will probably be revised down from 1.7 percent to 0.9 percent; inflation rate projections are likely to be revised up from 6.2 percent to 6.8 percent; and the "jobs bloodbath” will continue.

The political outlook is fraught: ruling party alliance partner, Cosatu, is threatened by the recent "toenadering” between the government and big business, and speculation concerning a possible increase in VAT, as well as the privatisation, or part-privatisation, of state-owned enterprises.

The view that the minister has a "free hand” to do what he likes seems exaggerated, especially given the back peddling on retirement reform relating to the Taxation Laws Amendment Act, following political pressure from Cosatu.

Whatever the case, the minister will have to "do things differently” to effectively respond to the economic crisis and the risk of a sovereign ratings downgrade.

Unemployment

There are 8.3 million people who do not have jobs, or have given up looking for jobs. We believe that giving hope, especially to the 5.4 million young people who do not have jobs, or who have given up looking for jobs, is imperative.

An employment tax incentive (ETI) was implemented after a long political battle by our party for a Youth Wage Subsidy, which culminated in a bloody march to Cosatu House in 2012.

The ETI incentivises employers to provide young people between the ages of 18 and 29 with jobs and work experience.

A total of 36 000 employers have provided more than 250 000 jobs to young people at the cost of R3.9 billion under the ETI.

However, implementation of this incentive has not been without its problems. Because the incentive is claimed through the Pay As You Earn (PAYE) system, it has not been accessible to most small businesses, which earn below the tax threshold and pay little PAYE tax.

A new PAYE system meant that refunds for the ETI had to be checked and authorised manually by the SA Revenue Service. And questions have been raised about the effectiveness of the incentive with one study finding that it had no significant effect on youth unemployment.

Whatever the case, the ETI Act is clear: an employer may not receive the employment tax incentive after January 1, 2017. The incentive, in other words, lapses in the 2016/17 financial year.

We believe the minister should announce a review of the implementation of the ETI and allocate funding for a rollover of the incentive between 2016/17 and 2019/20.

Avoiding junk status

Ratings agencies are circling South Africa like sharks, ready to downgrade us to "junk status”. We are hovering just above sub-investment grade territory.

A sovereign ratings downgrade will raise the cost of borrowing, result in capital outflows, lead to further currency weakness and increase the cost of living for ordinary people in South Africa.

The ratings agencies are monitoring several potential "risk factors”, including weak economic growth, fiscal consolidation, debt levels and state-owned enterprises.

Economic growth

The National Development Plan (NDP) envisages economic growth rates at an average of 5.4 percent per year, every year between 2010 and 2030.

This now seems impossible with economic growth rates being revised down for 2016: from 1.5 percent to 0.9 percent by the SA Reserve Bank; from 1.3 percent to 0.7 percent by the International Monetary Fund; and from 1.4 percent to 0.8 percent by the World Bank.

The South Africa Economic Update, released by the World Bank, finds that we now require an average economic growth rate of 7.2 percent per year to meet the targets set out in the NDP.

The biggest binding constraints holding the economy back include: a shortage of electricity, an inflexible labour market and a skills mismatch. However, when it comes to economic growth, there is little the minister can do, given that the structural reform needed would require fundamental changes to economic policy.

What the minister has done in the past has been to outline measures being implemented to increase economic growth, but in reality has been left virtually begging cabinet colleagues to implement the NDP.

The fact that the State of the Nation address contained no new measures to implement structural reform to boost economic growth and create jobs makes a sovereign ratings downgrade more likely.

Fiscal consolidation

The former minister of finance, Nhlanhla Nene, announced in his medium-term budget policy statement in 2014 that we had reached a "turning point”, and announced measures to narrow the budget deficit, stabilise debt and rebuild fiscal space.

Shortly after being appointed, the new minister made a clear commitment, at a press conference on December 14, to continue the fiscal consolidation process and maintain the main budget non-interest expenditure ceiling, which was set at R1.15 trillion for 2016/17.

Revenue

However, weaker-than-projected economic growth is expected to result in lower-than-expected consolidated revenue of R1.31trln in 2016/17. This despite additional revenue raising measures including, principally, (1) an increase in personal income tax by 1 percentage point for all taxpayers earning more than R181 000; (2) an increase in the fuel levy by 80.5 cents per litre; and (3) revising gross tax revenue targets down by R14.6bn for 2016/17.

There will be significant revenue shortfalls in 2015/16 and 2016/17. We, therefore, expect further tax increases to be announced in the Budget, including possibly raising personal income tax, dividends tax, capital gains tax and perhaps VAT.

We believe that instead of tax increases the minister should announce that revenue will be raised through the sale of:

  • Non-strategic liquid assets, such as the sale of the government’s stake in Telkom, which could raise an estimated R11bn in revenue.
  • Non-strategic immovable assets, such as land and buildings, which could also raise billions of rands in revenue.

The sale of the government’s stake in Vodacom was a good start, raising R25.4bn in revenue in 2015/16. However, we believe that any future revenue raised through asset sales should be "ring-fenced” and spent on the development of infrastructure to boost economic growth and job creation in the country.

Expenditure 

The measures announced in the medium-term budget policy statement last year to narrow the budget deficit, stabilise debt and rebuild fiscal space were aimed at creating a sustainable foundation for public finances. This was to be achieved by reducing the expenditure ceiling, slashing spending on non-core goods and services, and providing budget-neutral support for state-owned enterprises.

The cost containment measures are important, and they do send the right fiscal signals, but they are largely fiscal spin, providing political cover for failing to deal with the really big fiscal risks and mega projects including:

  • The nuclear build programme.
  • The national health insurance scheme.
  • The public sector wage bill, which, because of an inflation linked increment, will be revised up and cost more than the estimated R524bn (2016/17), R569.4bn (2017/18) and R615.6bn in 2018/19.

We need real spending cuts, rather than cost containment measures. 

We believe the minister should announce a comprehensive spending review aimed at identifying savings and eliminating wasteful expenditure in all three spheres of government.

A comprehensive spending review would entail: the Treasury, working together with national departments, provinces and municipalities, would review the composition of spending, the efficiency of spending and future spending priorities on the nuclear build programme, national health insurance and the public sector wage bill.

The review would ensure that the burden of spending cuts falls on consumption expenditure rather than on investment expenditure, and does not fall disproportionally on provinces and municipalities.

Balance

The lower-than-expected revenue, taken together with the higher than-expected expenditure, will put pressure on the estimated consolidated budget balance of minus 145.3bn or minus 3.3 percent of gross domestic product (GDP), in 2016/17. This is likely to increase the borrowing requirement, above the estimated minus R165.4bn or minus 3.7 percent of GDP in 2016/17.

Whatever the case, the consolidated budget balance of minus R145.3bn or minus 3.3 percent of GDP will breach the "red line” of 3 percent of GDP, in 2016/17.

Debt

Gross loan debt is expected to rise from R2.15trln, or 48.6 percent of GDP, in 2016/17 to R2.59trln, or 49.4 percent of GDP, in 2018/19. Net loan debt is expected to rise from R1.94trln, or 43.5 percent of GDP, in 2016/17 to R2.38trln, or 45.4 percent of GDP, in 2018/19.

The rate at which debt levels are increasing is alarming: net loan debt increased by R1.3trln, or 239 percent, from R526bn in 2008/2009 to R1.8trln in 2015/16.

Debt service costs, including debt repayments and interest payments on debt, are now the fastest-growing expenditure item in the Budget. Debt service costs are projected to be R142.6bn (2016/17), R157.2bn (2017/18) and R174.6bn (2018/19). This means we will be spending about R474.4bn over the next three years on debt service costs, which is more than double the R203.5bn we will spend on basic education in 2015/16.

And high debt service costs are crowding out social spending and are set to increase unless debt levels are stabilised.

The fact is that the decision to fire the former minister of finance, Nhlanhla Nene, shattered confidence in government’s commitment to hold the fiscal line.

And so, to avoid a ratings downgrade, the minister will have to show, using a combination of revenue raising measures and expenditure cuts, that he is absolutely committed to fiscal consolidation by:

  • Reducing the consolidated budget deficit to below 3 percent of GDP in 2016/17.
  • Maintaining a consolidated budget deficit below 3 percent of GDP between 2016/17 and 2019/20.
  • Maintaining the debt-to-GDP ratio below 50 percent in 2016/17.
  • Maintaining the debt-to-GDP ratio below 50 percent between 2016/17 and 2019/20.

But this is unlikely to be enough to avoid a ratings downgrade in South Africa.

State-owned enterprises 

There are 300 state-owned enterprises with a net asset value estimated to be R274bn in 2013/14.

A presidential review committee on state-owned entities made recommendations to improve the performance of state-owned enterprises in 2013. These recommendations included inter alia "Recommendation 20” as follows:

"Private sector participation in partnering with state-owned enterprises to deliver on the provision of both economic and social infrastructure should be encouraged and expanded.”

The committee’s findings were discussed at the 2015 cabinet "lekgotla” and it was agreed that the government would explore options for private investment to strengthen balance sheets and create opportunities for private investment in sectors dominated by state-owned enterprises. However, since then little or no progress has been made, save for the Renewable Energy Independent Power Producers Programme.

There are a number of failing state-owned enterprises, including SAA. The national airline is technically insolvent and requires a further guarantee, which is believed to be R4bn to R5bn. This will amount to a total guarantee of almost R20bn.

Provision for contingent liabilities are expected to increase by R311.2bn, or 38.5 percent, from R195.3bn in 2008/09 to R506.5bn in 2016/17.

We believe the minister should announce that the findings of the presidential review committee on state-owned entities will be implemented, including "Recommendation 20”, providing for private sector investment in failing state-owned enterprises.

But, we believe that the minister needs to go further and announce the privatisation of some state-owned enterprises, including SAA.

Conclusion

To conclude, Gordhan, faces five big challenges going into the Budget, including (1) dealing with high levels of unemployment; (2) avoiding a sovereign ratings downgrade; (3) providing relief to poor households; (4) dealing with the student fees crisis and (5) providing drought relief.

However, to get the economics right, the minister will have to get the politics right.

The minister’s capacity to do things differently is limited by the political space available inside the ANC/SACP/Cosatu alliance. The temperature inside the ruling party alliance is already red-hot following the battle over retirement reforms.

And Cosatu is opposed to rolling over the employment tax incentive, increasing VAT and the privatisation of state-owned enterprises. All this will limit the minister’s ability to effectively respond to the economic crisis and the risk of a ratings downgrade in South Africa.

* David Maynier is the DA’s shadow minister of finance.

This article first appeared on iol.co.za.


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