South African National Budget 2018/2019 a brief review

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1 South African National Budget 2018/2019 a brief review The South African Minister of Finance, Malusi Gigaba, delivered his first National Budget on Wednesday, 21 February This was one of the most widely anticipated National Budgets in recent years. In particular, ahead of the budget there was significant debate about possible tax changes, including the increase in the VAT rate, as well as the need for government to control key expenditure items such as salary payments, but also fund tertiary education and national health insurance. The demands on the Minister, however, extended well beyond issues relating purely to revenue and expenditure. These included the urgency for government to start to reform the management and financing of State Owned Enterprises (SOEs), the need to clarify key economic policies, the importance of lifting business confidence as well as avoiding any further credit rating downgrades. A daunting set of demands for any Minister of Finance. Although it is clear that government s fiscal parameters have deteriorated substantially in recent years, leading to successive credit rating downgrades, the Minister was able to present a budget that is significantly better than the Medium Term Budget Policy Statement (MTBPS) issued in October Back in October 2017, the MTBPS reflected a shock deterioration in all of the government s key fiscal parameters, especially revenue collection, and government debt. This dramatically increased the chances that South Africa s credit rating could be cut to below investment grade by all of the rating agencies. Fortunately, the latest set of budget parameters, together with recent political developments, greatly reduces the chances of further credit downgrades in the short-term. Nevertheless, a significant amount of work still needs to be done to lift business and consumer confidence, encourage private sector investment and sustainably raise economic growth. Government s latest growth projection of just over 2% in 2020 is hopelessly below the level South Africa requires to create employment, lift incomes meaningfully and reduce inequality. The 2018/2019 budget numbers For the 2018/19 fiscal year the Minister of Finance announced that the budget balance should improve to -3.6% of GDP, down from -4.3% of GDP in 2017/2018. This is slightly better than the deficit the Minister projected in the October 2017 Medium Term Budget Policy Statement (MTBPS). The fiscal deficit is then expected to remain unchanged in 2019/2020 as a percentage of GDP, before falling to -3.5% of GDP in 2020/21. It should be mentioned that in prior years the government had aimed to reduce the budget deficit to below -3% of GDP, but clearly the sustained lack of economic growth coupled with subdued revenue collection has thwarted those ambitions. The government also intends to achieve a primary budget surplus (which is the budget deficit less interest costs) of 0.1% of GDP in the current fiscal year. This would be a very welcome achievement, after recording a primary budget deficit of -0.7% of GDP in the past fiscal year, and will go a long way towards convincing the public, investors and credit rating agencies that government is serious about its intention to achieve a more disciplined financial framework. Unfortunately, while the projected reduction in the budget deficit and improvement in the primary balance over the next three years reflects an intention to adhere to fiscal discipline, South Africa s National Treasury has developed a reputation in recent years for not being able to achieve the targets articulated in the budget. Consequently, the emphasis within government s economic policy will now have to focus very heavily on raising economic growth on a sustainable basis. Without an acceleration in economic activity, the fiscal authorities will once-again struggle to improve tax collection and meet their budget objectives. It is also clear that given the current balance sheet constraints within central government as well as SOE sector, economic policy will have to increasingly promote the role of the private sector in driving economic growth. We would hope this includes a greater reliance on Private-public partnerships. The revenue side of the budget In 2017/2018 tax revenue massively underperformed budget by an estimate R48.2 billion. While this is largely in-line with the revenue shortfall the minister highlighted in the October 2017 MTBPS, it represents a huge miscalculation by National Treasury and meant that government had to borrow substantially more than it had anticipated at the start of the fiscal year. A breakdown of this revenue shortfall shows that the under-collection has been very broad-based and includes a dramatic R21 billion shortfall in individual tax collection, a R14 billion under-collection of VAT and a R3.6 billion lapse in the collection of customs duties. In contrast, company tax collection was in-line with budget, while the fuel levy exceeded budget. Unfortunately, the latest revenue shortfall means that government has missed their revenue targets for four consecutive years, forcing the authorities to look for additional sources of funding. Back in the 2017/2018 budget the emphasis was on increasing in the top marginal tax rate for individuals from 41% to 45%, whereas in the latest budget the decision was taken to increase the VAT rate from 14% to 15%. The authorities hope that by increasing VAT by 1 percentage points they can raise an addition R22.9 billion. This certainly seems ambitious in an economy that is projected to grow by a mere 1.5%.

2 Other significant tax changes announced in the budget included a sizeable increase in the fuel levy as well as the road accident fund, a below inflation adjustment to the tax thresholds for individual taxes, an increase in estate duty, a hike in the normal range of excise duties, a moderation in the medical aid tax credits and the inclusion of a range of taxes relating to the environment and health. Government estimates that the increase in VAT together with the other tax changes we highlighted, will yield an additional R36 billion in tax review. Overall, the decision by government to raise the VAT rate was clearly not easy, especially considering the social and political risks associated with an increase in any regressive tax under conditions of high unemployment. Nevertheless, the decision seems appropriate given the need to broaden the revenue base and not simply rely on further increases in the top marginal tax rate. Ultimately, though, the tough decision government has had to make on raising taxes in recent years reflects the consequences of a lack of job creation. The expenditure side of the budget In 2018/2019 government expects to spend a total of R1.67 trillion, which is 7.3% more than it spent in 2017/2018. This is modestly higher than the projected inflation rate of 5.3%, allowing government to largely adhere to its expenditure ceiling Importantly, spending on staff and salaries, which consumes 35% of all expenditure, is projected to grow at an average of 7.3% per annum over the next 3 years, highlighting government s commitment to containing the rate of increase in consumption spending. A key area of growth in government spending during 2018/2019 is education, especially post-school education and training. In total government has allocated an additional R57 billion of new spending fee-free higher education and training over the next 3 years. This reflects government earlier promises to help students that are currently struggling to afford higher education, especially tertiary education. There is also a sizeable increase in social spending, with the number of social grants recipients projected to rise to over 18 million in To some extent, the latest increase in spending on social grants reflects an attempt by government to offset the negative impact of a higher VAT rate on poorer households. While this initiative is to be applauded, it also raises the base of social spending in South Africa which will become increasingly problematic without an immediate and sustained rise in employment. The government s healthcare budget will also see a sizeable increase in expenditure over the next three year. Government has indicated that they are continuing to implement National Health Insurance (NHI) and decided to support this initiative by reducing the tax credits to medical scheme as a means of increasing the funding the future expansion of the NHI. Lastly, and unfortunately, there is still not enough in the budget to directly promote job creation. South Africa s unemployment rate remains far too high by historical and international standards, and clearly contributes much of the social tension and anguish experienced in South Africa on a daily basis. Increasing employment in South Africa has to be the number one economic/political/social objective. Debt servicing costs continue to rise at a very rapid pace While South Africa s public sector debt parameters are now projected to improve relative to the disastrous projection outlined in the MTBPS, the total debt as well as the cost of servicing that debt is clearly on the rise. For example, back in 2009, government s gross debt totaled only 26% of GDP and is projected at 53% in 2018/2019. If left unchecked, government debt will quickly become a major hindrance to achieving many vital policy objectives. In addition, a key risk to South Africa s ongoing fiscal stability is the increase in state debt cost. While the interest cost on state debt remains manageable at just below 12% of total expenditure, it is now consistently the fastest growing component of government expenditure. In fact, nominal growth in interest and rent on land is expected to average well over 10 per cent over the next three years. Under these circumstances, a significant rise in bond yields, due to further credit rating downgrades, would put South Africa s fiscal position under increasing strain. Already the cost of debt exceeds the total budget allocation to public order and safety and is one of the fastest rising components of state spending. Conclusion The 2018 National Budget was presented in an environment of intense scrutiny and high expectations. The dramatic revenue undercollection and weak economic growth meant National Treasury had to make tough decisions. Either it had to decide to allow the budget deficit to increase significantly further in 2018/2019 and thereby risk an almost certain ratings downgrade to below investment

3 grade by Moodys in March 2018, or it had to decide to do the unpopular thing and raise the VAT rate. Treasury obviously chose the tax hike option, which has allowed them to reflect a clear intention to restore fiscal discipline, giving South Africa a better than 50% chance of maintaining its investment credit rating by Moodys. However, and very importantly, the trade-off for this policy choice is that the recent tax hikes (VAT and others) will undoubtedly hurt the weak economic environment, potentially depressing the already subdued rate of economic expansion in key sectors of the economy. This means that government needs to urgently focus on removing the key factors constraining economic growth. These factors include policy uncertainty, high levels of corruption in both the private and public sectors, poorly performing SOEs, a lack of fiscal discipline and low levels of business confidence. Some of these constraints might be relatively easy to resolve, such as scrapping the proposed mining charter, while others would require a larger degree of policy innovation such as the extensive use of private-public partnerships fortunately the use of privatepublic partnerships, as well as the sale of non-strategic state assets, were highlighted as policy options in the budget. Clearly, some of the constraints outlined above will prove more difficult to resolve than others, but as the long as government demonstrates a firm and ongoing commitment to lifting economic growth while at the same time maintaining fiscal discipline, business confidence and investment will follow. Regards Kevin Lings Chief Economist

4 South Africa s National Budget 2018 Kevin Lings February 2018

5 World vs SA GDP, annual growth rate %y/y World South Africa

6 South Africa business confidence (BER) Index

7 SA consumer confidence (BER) Index

8 5 ECONOMIC CHALLENGES FACING THE COUNTRY 1. Lift business confidence 2. Restore fiscal discipline 3. Reform State Owned Enterprises (SOEs) 4. Ensure clear & consistent transformation policies 5. Dramatically reduce corruption

9 SA GDP annual growth rate (government estimate) %y/y Government forecast

10 SA growth in fixed investment (government estimate) %y/y Government forecast

11 SA political economy in need of substantial reform 8

12 Open Budget Index 2017 Index out of 100 South Africa NZ Sweden Norway Mexico US Brazil UK France Italy Russia Germany Portugal Czech South Korea Turkey Chile Thailand Spain Namibia Argentina Ghana India Kenya Malaysia Morocco Nigeria Vietnam China Botswana Zambia Saudi

13 21/22 20/21 18/19 17/18 16/17 15/16 14/15 13/14 '12/13 '11/12 '10/11 '09/10 '08/09 '07/08 '06/07 '05/06 '04/05 '03/04 '02/03 SA Budget Deficit as % of GDP % Fiscal years

14 20/21 19/20 18/19 17/18 16/17 15/16 14/15 SA primary budget balance as % of GDP % Fiscal years

15 Breakdown of SA tax revenue (2018/2019) Other 5.0% Individuals 38.0% Customs duties 4.0% Excise duties 3.0% Fuel levy 6.0% Companies 18.0% VAT 26.0%

16 2017/ / / / / / / / / / / / / / / / / / / /99 SA Budget Revenue Over-runs/under-collection Rbn, relative to the original budget and not the MTBPS

17 Fuel levy Taxes on property Companies Other Excise duties Customs duties VAT Individual tax SA tax revenue shortfall in 2017/2018 (-R48.2bn) Rbn

18 SA main tax proposals 2018/2019 (+R36 billion) Personal income tax Fiscal drag: revenue from not fully adjusting for inflation Medical tax credit adjustment Corporate tax Special economic zones Taxes on property Estate duty increase Indirect taxes Increase in VAT Increase in general fuel levy Increase in excise duties Increase in environmental taxes Introduction of health promotion levy GAIN ON TAX PROPOSALS Additions Rm Subtractions Rm 350

19 UK Europe Asia USA Netherlands OECD World China South America South Africa Africa Oceania % Global comparison of corporate tax rates

20 Nigeria Thailand Japan Australia Indonesia Bostwana South Africa Namibia Kenya Mexico Zambia China Peru Turkey Chile Germany France UK Spain Italy Portugal Ireland Greece Global comparison of VAT tax rates %

21 South Africa s fuel levy Cents per litre Since 2009 the average annual increase in the fuel levy has averaged 11.4% This compares with an average inflation rate of 5.4%

22 Estimates of individual taxpayers contribution Percentage of personal tax before tax adjustments Percentage of personal tax after 2018/2019 tax changes R0 to R R to R R to R R to R R to R R to R R to R R to R R

23 18/19 17/18 16/17 15/16 14/15 13/14 '12/13 '11/12 '10/11 '09/10 '08/09 '07/08 '06/07 '05/06 '04/05 SA growth in individual income tax % Fiscal years Inflation has averaged 5% over the period

24 SA budget revenue increases 2018/2019 Companies Dividend Tax Transfer Duties Customs Duty Skills Development Levy General Fuel Levy Specific Excise Duties Individuals TOTAL REVENUE TAX REVENUE Value-Added Tax Inflation 6.0% 6.2% 6.9% 7.3% 7.3% 8.6% 9.1% 9.7% 10.1% 10.5% 16.4% 21

25 20/21 19/20 18/19 17/18 16/17 15/16 14/15 13/14 '12/13 '11/12 '10/11 '09/10 '08/09 '07/08 '06/07 '05/06 '04/05 '03/04 '02/03 '01/02 00/01 99/00 98/99 97/98 96/97 95/96 94/95 93/94 92/93 91/92 90/91 Customs Union payments by SA government Rbn

26 SA breakdown of expenditure 2018/2019 Social Protection, 12.9 State Debt, 11.8 Defence, 3.1 Public Order and Safety, 9.5 Education, 22.5 Economic Affairs, 10.5 Recreation and Culture, 0.8 Health, 13.1 Housing and Community, 9.4 Environmental Protection, 0.5

27 SA budget expenditure increases in 2018/19 %y/y Education State Debt Housing and Community Social Protection Total Health Public Order and Safety Environmental Protection Recreation and Culture Defence Consolidated national and provincial expenditure

28 SA Social Grant Beneficiary Numbers Number of people obtaining a social grant

SA government gross loan debt as % of GDP % 60 55 50 45 40 35

29 SA government gross loan debt as % of GDP %

30 24/25 23/24 22/23 21/22 20/21 19/20 18/19 17/18 16/17 15/16 14/15 13/14 12/13 SA government debt outlook Rbn Fiscal years /2018 Budget February

31 25/26 24/25 23/24 22/23 21/22 20/21 19/20 18/19 17/18 16/17 15/16 14/15 13/14 12/13 SA government debt outlook Rbn Fiscal years Revised estimates October /2018 Budget February

32 25/26 24/25 23/24 22/23 21/22 20/21 19/20 18/19 17/18 16/17 15/16 14/15 13/14 12/13 SA government debt outlook Rbn Fiscal years Revised estimates October /2018 Budget February /2019 Budget February

33 20/21 19/20 18/19 17/18 16/17 15/16 14/15 13/14 12/13 11/12 10/11 09/10 08/09 07/08 06/07 05/06 04/05 03/04 02/03 01/02 00/01 99/00 98/99 97/98 96/97 95/96 94/95 93/94 92/93 91/92 90/91 89/90 SA government net domestic long-term bonds Rbn Fiscal years

34 Russia Turkey Emerging Europe Australia China Emerging Economies Emerging Asia South Africa Mexico Latin America Germany India Ireland Brazil Euro area UK Canada France Spain Advanced Economies United States G7 Portugal Italy Greece Japan Government debt as % of GDP 2017 (IMF data) %

35 18/19 17/18 16/17 15/16 14/15 13/14 12/13 11/12 10/11 09/10 08/09 07/08 06/07 05/06 04/05 03/04 02/03 01/02 00/01 99/00 98/99 97/98 SA government net foreign funding Rbn Fiscal years

36 Foreign holding of SA bond market Percentage of market

37 20/21 19/20 18/19 17/18 16/17 15/16 14/15 13/14 12/13 11/12 10/11 09/10 08/09 07/08 06/07 05/06 04/05 03/04 02/03 01/02 00/01 99/00 98/99 97/98 96/97 95/96 94/95 93/94 92/93 91/92 90/91 89/90 SA debt servicing costs as % of total spending % Fiscal years

38 Growth in fixed investment spending by State Owned Enterprises (SOEs) % year-on-year, 4-quarter moving ave

39 20/21 19/20 18/19 17/18 16/17 15/16 14/15 13/14 12/13 11/12 10/11 09/10 08/09 07/08 06/07 SA government contingent liabilities Rbn Fiscal years Contingent liabilities average annual growth 16%

40 Government contingent liabilities 2017/2018 R billion Road Accident Fund, Trans-Caledon Tunnel, 18.8 Other, SANRAL, 28.4 SAA, 11.8 Independent power producers, Eskom, 235.8

41 Sovereign credit ratings of South Africa Moody s Standard & Poor s Fitch Rating Date Rating Date Rating Date Aaa AAA AAA Aa1 AA+ AA+ Investment grade Aa2 Aa3 A1 A2 AA AA- A+ A AA AA- A+ A A3 16 Jul 2009 A- A- Baa1 11 Jan 2005 / 27 Sep 2012 BBB+ 1 Aug 2005 BBB+ 25 Aug 2005 Baa2 29 Nov 2001/6 Nov 2014 BBB 7 May 2003 / 12 Oct 2012 BBB 2 May 2003/10 Jan 2013 Baa3 30 May 1995/9 June 2017 BBB- 25 Feb 2000/13 June 2014 BBB- 27 June 2000/4 Dec 2015 grade Speculative Ba1 Ba2 Ba3 BB+ BB BB- 20 Nov 1995 / 3 April Oct 1994 BB+ BB BB- 19 May 1995 / 7 April Sept 1994

42 South Africa s credit rating by S&P Credit rating A- 6 BBB+ 5 BBB 4 Investment grade cut-off BBB- 3 BB+ 2 SA international credit rating BB 1 0

43 SA 10-year government bond yield %, yield Inflation target introduced in February 2000

44 Rand exchange rand against US Dollar Rand per US Dollar

45 Evaluating the SA national budget Budget objectives clearly stated Budget deficit contained Revenue : Appropriate composition No ad hoc measures Efficiency of collection Spending: Appropriately allocated Public sector salary increases contained Increases in public sector investment Positive impact on the economy: Growth Inflation Encouraging private sector investment Help encourage job creation Provide poverty relief/welfare Encourage savings Encourage small business Innovation Negative No No No No No No No No No No No Positive Yes Yes Yes Yes Yes

46 Thank you

South Africa: National Budget 2009/2010 Budgeting during a global credit and economic crisis. Kevin Lings Economist 12 February 2009

South Africa: National Budget 2009/2010 Budgeting during a global credit and economic crisis Kevin Lings Economist 12 February 2009 US monthly payroll changes 000 s 600 500 400 300 200 100 0-100 -200-300