MTBPS Preview: perceived positive Moody s review does not belie that debt stabilization, particularly SOE debt stabilization, is still required

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1 Figure 1: Expenditure continues to outpace revenue vs revenue performance and projections Revenue vs expenditure vs deficit 40 1 Revenue actual and projected % GDP / /98 005/06 013/14 Budget Balance (Deficit-/Surplus+) Tax Revenue as % GDP Expenditure % GDP /04 007/08 011/1 015/16 019/0 Personal income tax VAT Corporate income tax Customs duties Sources: SARB, National Treasury With a new Finance Minister, October s mini-budget will be keenly watched, but will likely deliver a very similar path to the Budget released at the start of the year. This fiscal year the fiscal deficit as a % of GDP will likely widen (vs. projected), with above budgeted civil servant wage increases, while revenues are weak and previous tax buoyancy expectations were likely overly optimistic. Looking forward, reprioritisation of spending and the infrastructure fund are also on the cards, while revenue underperformance will likely spur some further debate on tax increases. Any actual material tax increases are not expected, occurring instead at the 019 budget. SA continues to face higher taxation, both indirectly and directly, but has failed to scale back real expenditure growth. Higher taxes and utility costs have contributed to slowing economic growth, and this partial procyclical fiscal policy stance (substantial tax increases) is likely to continue in the medium-term. Indeed, personal income taxes and the super wealthy (gross income of R7m plus) are likely to be discussed (but not hiked in the MTBPS), with the new Minister a wealth tax proponent. The rating agencies will look for fiscal slippage (widening deficit or higher debt projections as a % of GDP), and should the MTBPS deliver materially higher public sector debt (and indicate higher SOE contingent liabilities) projections, the credit rating agencies would see this as credit negative. This year the Medium-Term Budget Policy Statement (MTBPS) takes place on 4 th October 018, and revisions to SA s fiscal deficit, inflation, GDP and net debt projections are all expected, as well as information on potential future tax changes and funding for SOEs. Details (particularly finances) of the Economic Stimulus and Recovery Plan, with its objectives to ignite economic activity, restore investor confidence, create jobs, aid the vulnerable and repair municipalities, are also expected. Figure : National revenue, expenditure and borrowings: R million unless otherwise stated Aug 018 Fiscal year to 018/19 % of Last year: % date budget budget budget Revenue: Expenditure: Deficit/borrowings: Annabel Bishop Investec Bank Limited Tel (711) annabel.bishop@investec.co.za 1

2 Figure 3: Financing R million August 018 August 017 Domestic short-term loans (3 681) 8 66 Domestic long-term loans Foreign Loans - - Change in cash and other balances1 (3 704) (10 690) Total financing (net) ) A negative value indicates an increase in cash and other balances. A positive value indicates that cash is used to finance part of the borrowing requirement Figure 4: Main Budget Balances 011/ 01/ 013/ 014/ 015/ 016/ 017/ 018/ 019/ 00/ Budget % -4.1% MTBPS % -3.9% -3.% Budget % -4.8% -3.8% MTBPS % -5.% -4.5% -3.3% Budget % -4.6% -4.0% -3.0% MTBPS 01-4.% -4.8% -4.5% -3.7% -3.1% Budget % -5.% -4.6% -3.9% -3.1% MTBPS % -4.% -4.% -4.1% -3.8% -3.0% Budget % -4.3% -4.0% -4.0% -3.6% -.8% MTBPS % -4.3% -3.9% -4.1% -3.6% -.6% -.5% Budget % -4.1% -3.8% -3.9% -3.9% -.6% -.5% MTBPS % -4.1% -3.8% -3.6% -3.8% -3.3% -3.% \ -3.0% Budget % -5.0% -4.4% -4.3% -4.1% -3.9% -3.5% -3.3% -3.3% MTBPS % -4.1% -3.8% -4.7% -4.5% -4.6% -4.6% Budget % -5.0% -4.4% -4.3% -4.1% -3.8% -4.6% -3.8% -3.8% -3.7% Figure 5: Expenditure ceiling 1 R billion/percentage change 015/16 016/17 017/18 018/19 019/0 00/1 016 Budget Review MTBPS Budget Review MTBPS Budget Review ) Non-interest spending financed from the National Revenue Fund excluding skills development levy, special appropriations in 015/16 for Eskom and the New Development Bank, debt management and Gold and Foreign Exchange Contingency Reserve Account transactions and the International Oil Pollution Compensation Fund Annabel Bishop Investec Bank Limited Tel (711) annabel.bishop@investec.co.za

3 Figure 6: Gross debt-to GDP outlook and Budget deficit projection slightly wider 65 Gross debt to GDP outlook % of GDP Budget deficit projection % of GDP /13 015/16 018/19 01/ 04/5 008/09 011/1 014/15 017/18 00/1 017 MTBPS 017 Budget 018 Budget Consolidated budget deficit Moody s recently released a regular update on its credit opinion of South Africa, warning of a rating downgrade if South Africa fails to stabilize its debt, lift economic growth or/and sees an increase in the likelihood that SOE contingent liabilities will lift its sovereign debt burden. The agency recognises the socio political issues in SA which has led to populist spending pressure in a low growth, high unemployment environment, as poverty levels are substantial. However, it is also reported to highlight, as it did in its March review, that the change in political leadership in SA this year is expected to bolster institutional strength, strengthen government s resolve to fiscal consolidation, and improved financial governance of the SOEs, as well as strengthening the outlook for GDP growth. Indeed such a positive outcome above, if it occurs, is signalled as supportive of a credit rating upgrade. Figure 7: Share of total tax expenditure per tax type and tax expenditure as a share of tax revenues and nominal GDP Share of total tax expenditure per tax type % Tax expenditure as a share of tax revenues and % nominal GDP / / % Personal income tax Corporate income tax Value-added tax Customs and excise duties /13 013/14 014/15 015/16 Tax expenditure/gross tax revenue Tax expenditure/nominal GDP (right axis), Annabel Bishop Investec Bank Limited Tel (711) annabel.bishop@investec.co.za 3

4 Figure 8: Consolidated government fiscal framework, 015/16-00/1 015/16 016/17 017/18 018/19 019/0 00/1 R billion/percentage of GDP Outcome Revised Medium-term estimates Revenue % 9.% 8.8% 9.7% 9.9% 9.9% Expenditure % 3.7% 33.% 33.3% 33.4% 33.4% Budget balance % -3.5% -4.3% -3.6% -3.6% -3.5% Primary Balance % -0.1% 0.1% 0.4% 0.9% 1.1% Figure 9: Main budget revenue and non-interest spending 8 Per cent of GDP /06 006/07 007/08 008/09 009/10 010/11 011/1 Revenue 01/13 013/14 014/15 015/16 016/17 017/18 Non-interest spending 018/19 019/0 00/1 Figure 10: Macro-economic forecasts, National Treasury vs. Investec Final household consumption Investec Gross fixed capital formation Investec Exports Investec Imports Investec Real GDP Investec CPI Inflation Investec Current account deficit (% GDP) Investec , Investec Annabel Bishop Investec Bank Limited Tel (711) annabel.bishop@investec.co.za 4

5 Figure 11: Borrowings: R million unless otherwise stated 016/17 017/18 018/19 019/0 00/1 Outcome Budget Revised Medium-term Estimates Domestic short-term loans Domestic long-term loans Foreign loans Change in cash and other balances Total borrowing A positive /negative change indicates a decrease/increase in cash balances. The previous core factors underpinning the rating remains the strength of the judiciary, sophistication and depth of SA s financial markets, the health of the banking system and low levels of foreign debt. Moody s continues to believe that SA will achieve fiscal consolidation over its medium-term framework. The October MTBPS (Medium-Term Budget Policy Statement) will consequently remain key to Moody s ongoing assessment, the last of the three key agencies to have South Africa rated investment grade. The rating is on a dual basis (both foreign and local currency long-term sovereign debt) on Baa3, and loss of this investment grade rating is estimated to result in higher borrowing costs, marked currency weakness and upward pressure on short-term interest rates. Historically, countries which have seen their ratings from the key agencies migrate from investment to sub-investment grade have had a significant market impact. Indeed, Russia, Turkey, Brazil and Hungary saw their ten year government bond yields rise by about 130bp on average at the time of downgrade, versus three months before. The historic average in a migration from investment to subinvestment grade for these four countries shows about a 0bp rise in short-term interest rates. The SARB previously estimated up to a 75bp rise in the repo rate, which could temper the money market interest rate moves somewhat in comparison, to closer to 100bp, or likely less. In addition, South Figure 1: Total public-service employment; Average cost-of living adjustments and inflation Total public-service employment Millions 1 % Average cost-of-living adjustments and (full-time equivalants) inflation Salary level 1-1 Management (level 13-16) CPI inflation, Annabel Bishop Investec Bank Limited Tel (711) annabel.bishop@investec.co.za 5

6 Figure 13: Contribution to gross tax revenue and comparative standard VAT rates by country* Contribution to gross tax revenue by tax Comparative standard VAT rates by country* % instrument, 016/17 1 Persons and individuals Value-added tax Companies Fuel levy Customs duties Specific excise duties Dividend withholding tax Skills development levy Electricity levy Transfer duties % of gross tax revenue *Rates are for 017 and 018. The OECD rate refers to an unweighted average Argentina United Kingdom Madagascar Morocco Cameroon OECD India Russia Turkey Ivory Coast Rwanda Tanzania Uganda Brazil China Mozambique Malawi Mexico Kenya Ghana Mauritius Namibia Zimbabwe South Africa Botswana Indonesia South Korea Japan Nigeria Saudi Arabia, Figure 14: Corporate income tax as a share of GDP* and nominal spending growth by function over MTEF % Corporate income tax as a share of GDP* Nominal spending growth by function over 7 MTEF 6 5 Post-school education and training Debt-service costs Social protection Health Economic development Community development Basic education Peace and security 5. 1 General public services % 4.3 OECD Africa South Africa , *Average corporate income tax to GDP ratios for OECD and 16 African countries (Cape Verde, Cameroon, Democratic Republic of the Congo, Ivory Coast, Ghana, Kenya, Mauritius, Morocco, Niger, Rwanda, Senegal, South Africa, Swaziland, Togo, Tunisia and Uganda) 6.8 Annabel Bishop Investec Bank Limited Tel (711) annabel.bishop@investec.co.za 6

7 Figure 15: Bond yields before and after a downgrade from investment grade to sub-investment grade y prior 1y prior 6m prior 3m prior downgrade 3m post 6m post 1y post y post Brazil Russia Turkey Hungary Average Currencies before and after a downgrade from investment grade to sub-investment grade y prior 1y prior 6m prior 3m prior downgrade 3m post 6m post 1y post y post Brazil Russia Turkey Hungary Average Source: Rating Agencies, IRESS, IHS, Bloomberg s, Investec Africa has a sophisticated financial market, and the impact of the downgrades could be less severe than Russia, Turkey, Brazil and Hungary experienced. A significant downgrade is partially priced in for South Africa, while investors may also see higher yields as a buying opportunity. The market period, i.e. risk-on or risk-off, also will have a material impact, particularly on the rand effect. The revisions to South Africa s key fiscal projections in the MTBPS versus the Budget, namely the fiscal deficit and debt as a % of GDP, along with projected expenditure versus the expenditure ceiling, are not expected to be substantial. The fiscal deficit projection in the Budget for 018/19 is likely to widen Figure 16: Estimates of individual tax payers and taxable income, 018/19 Income tax Registered Taxable payable Taxable bracket individuals income before relief Income tax relief Income tax from medical Income tax payable after proposals Number % R bn % R bn % Rbn % R bn % R bn % 0 R R R R R R R R R R R R R R R R Total Grand total Annabel Bishop Investec Bank Limited Tel (711) annabel.bishop@investec.co.za 7

8 Figure 17: Rating Agency and Market Views Moody s Standard & Poor s Fitch Ratings Long-term Foreign Currency Debt Long-term Foreign Currency debt Long-term Foreign Currency Debt Baa3 BB BB+ Stable Stable Stable Long-term Domestic Currency Debt Long-term Domestic Currency Long-term Domestic Currency Debt Debt Baa3 BB+ BB+ Stable Stable Stable Source: Moody s, Standard & Poor s, Fitch Figure 18: Consolidated fiscal framework, 017/18 00/1 (Rbn and %) MTBPS / 18 Budget / 18 MTBPS / 19 Budget / 19 MTBPS / 0 Budget / 0 MTBPS / 1 Budget / 1 Revenue % of GDP 9.% 8.8% 9.7% 9.7% 30.0% 9.9% 9.9% 9.9% Expenditure % of GDP 33.5% 33.% 33.6% 33.3% 33.9% 33.4% 33.9% 33.4% Non-interest expenditure % of GDP 6.7% 9.5% 6.8% 9.5% 7.1% 9.6% 7.0% 9.6% Budget balance Percentage of GDP -4.3% -4.3% -3.9% -3.6% -3.9% -3.6% -3.9% -3.5% Gross domestic product Figure 19: Public-sector infrastructure spending R billion % of GDP /99 000/01 00/03 004/05 006/07 008/09 010/11 01/13 014/15 016/17 State-owned companies Provincial departments Local government Public entities Public-private partnerships National departments Total as a share of GDP (right axis), Annabel Bishop Investec Bank Limited Tel (711) annabel.bishop@investec.co.za

9 Table 0: Selected government guarantee exposure 015/16 016/17 017/18 R billion Guarantee Exposure Guarantee Exposure Guarantee Exposure Public institutions: Eskom SANRAL Trans-Caledon Tunnel Authority South African Airways Land and Agricultural Bank of South Africa Development Bank of Southern Africa South African Post Office Transnet Denel South African Express Industrial Development Corporation South African Reserve Bank Independent power producers Public-private partnerships Total amount of borrowing and accrued interest for the period under review. 3 These amounts only include National and provincial PPP agreements. to -3.8% of GDP from -3.6% of GDP in the Budget, while in 019/0 it is likely to be unchanged from -3.6% of GDP, and 00/1 lowered to -3.4% of GDP (-3.5% previously), with 01/ added in, at -3.4% of GDP. Government s gross loan debt was projected to peak at 56.% of GDP by 01/ in the February 018 Budget, and realistically cannot rise much further without concerning rating Figure 1: Revisions to main budget revenue and expenditure estimates 017/18 018/19 019/ R billion/% of GDP Budget Budget Budget Budget Budget Budget Current payments Compensation of employees Goods and services Debt-service costs Transfers and subsidies Payments for capital assets Payments for financial assets Contingency/ unallocated reserve Total % of GDP 9.7% 30.0% 9.7% 30.1% 9.8% 30.3% Annabel Bishop Investec Bank Limited Tel (711) annabel.bishop@investec.co.za 9

10 Figure : Consolidated government expenditure, Investec agencies. Similarly the expenditure ceiling is not expected to be breached in the projections, at least not for a sustained period, and may be lowered in the later years. The reprioritization of government expenditure to accommodate the R50bn identified in the Economic Stimulus Recovery Plan (ESRP) will be announced in the MTBPS, and much will likely come from unspent funds, with diversion in future funding from underperforming areas to the government initiatives. The ESRP has a range of measures, both financial and non-financial, aimed at igniting economic activity, restoring investor confidence, creating new jobs, aiding the vulnerable and embarking on a number of interventions into municipalities. Reprioritization of public spending within the current budget will occur (not a higher level of expenditure then budgeted) towards five areas to create jobs, the implementation of growth enhancing reforms, to establish an infrastructure fund, address health and education and invest in municipal social infrastructure improvement. Additionally, township industrial parks are planned. Davis Tax Committee has concluded its work, and the MTBPS may see the announcement of a new tax commission or committee to investigate sources of government revenue. The new Finance Minister, Tito Mboweni, will deliver the MTBPS, and has previously indicated his keen support for wealth taxes in SA. However, with much of the work on the MTBPS likely competed by National Treasury before the appointment of the new Minister of Finance, and with the Minister coming into a very large body of work to contend with, the MTBPS is not expected to show any marked deviations from February s Budget. Annabel Bishop Investec Bank Limited Tel (711) annabel.bishop@investec.co.za 10

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