Finance Minister Tito Mboweni addressed the country in the supplementary budget update on Wednesday the 24th of June 2020. The much-anticipated speech looked to address the “dangerously overstretched” financial situation in which South Africa finds itself due to the impact of the global COVID-19 pandemic. The purpose of this budget was to create a platform for a sustainable fiscus by stabilizing debt balanced while providing the financial means to look after the country’s citizens well-being. You can find a copy of the Ministers speech here and further supporting detail, including the recorded speech and detailed budget, here. After giving the market a few days to analyze and absorb the speech, several key items stand out, namely, tax reforms, foreign funding, public sector wage bill and zero-based budgeting.
Firstly, the budget speech itself was devoid of concrete tax reform proposals though some was included in the supporting material. Delving into the full budget proposal, the government highlights that their approach to improving tax revenue will be three pronged. Firstly, from improved tax collection, secondly, through additional tax measures and the final portion is expected from recovering economic activity and post-pandemic growth. It was noted that these additional tax measures will only be addressed in detail during the February 2021 Budget.
Increasing taxes is a very narrow bridge to cross. Lifting corporate tax rates is almost a non-starter given that government policy in the last few years has been in the opposite direction and given that there are tax-friendlier corporate tax regimes right here in Africa. The supplementary budget also highlighted that in order to support growth, focus would be placed on making it easier to do business in South Africa, increasing corporate tax would contradict this stance. The budget specifically identified international taxes as a way to increase tax revenue, through transfer pricing. This would most impact companies housing multiple legal entities stretching across borders and would focus on tax practices implemented in the exchanges between these companies. The South African Revenue Service currently implements the Organisation for Economic Co-operation and Developments (OECD) approach to transfer pricing; you can find more detail here.
Personal income taxes also have limited room to maneuver, though we will likely see no inflation-adjustment to offset bracket creep and we will likely see the maximum marginal tax rate rise, these will only be beneficial at the margin. Wealth taxes and capital gains taxes are politically palatable but the amount of revenue they generate is immaterial when considering that from 2021-2025 government would like taxes to increase between R5Bln - R15Bln each year. Also, one wonders just how much capital gains are available in the system to be taxed given the market environment. VAT has recently been lifted but given the extreme levels of poverty, a consumption-based tax is a political non-starter; though zero-rating more goods and services will ease some of this. Having zero-rated additional goods and services, the question that begs asking is the materiality of further VAT increases. A narrow bridge indeed.
The budget speech was clear about the need to look for foreign sources of funding for the government’s budget deficit, to the tune of $7Bln. The current intention is to borrow the majority in a $4.2Bln loan through International Monetary Fund (IMF) rapid financing instrument and further $1Bln through a loan from the New Development Bank (formally known as BRICS Development Bank). Whilst IMF and BRIC’s loans come at attractive rates of interest, they are expected to be repaid in hard currency terms. This changes the mix of foreign to local debt and will inevitably lead to higher local interest rates to compensate investors for the risk that some of government’s resources are going to be priced in a currency almost guaranteed to weaken over time. Speaking of the currency: the rand is well-known to be a very liquid emerging market currency and is often used by offshore investors as a proxy for aggregate emerging market risk. Prior to this point, South Africa had a small measure of gold and foreign reserves which could be used by the South African Reserve Bank to ensure orderly price discovery. This will be much more difficult to do if National Treasury is running significant dollar liabilities.
Public Sector Wage Bill
The massive R160.2Bln public sector wage bill has yet to be addressed. It clearly wasn’t in the budget speech as negotiations appeared to have been delicately poised at the time. Simply pausing on the 3-year deal will be a massive achievement but what really needs to happen is that the bloated public sector needs to be held to account and the wage bill needs to be redistributed. Ratings agencies, such as Fitch Ratings, anticipate any wage negotiations to be difficult, predicting that adjustments to the bill may not even be possible until the April 2021 expiry of the agreement. You can find a copy of their article here. One does wonder, and this is somewhat speculative, whether Ramaphosa’s administration has built enough goodwill through their coronavirus crisis response consensus building approach to have a real shot at addressing the public sector wage bill without massively compromising the portion of the electorate those wage earners represent.
Zero-based budgeting is a wolf in sheep’s clothing. Which could be catalytic if the Finance Ministry gets it right. Doing the budget this way forces every single line item to be justified and accounted for and leaves very little place to hide wasteful expenditure. Zero-based budgeting also includes the phasing out of programs that lack service delivery and have minimal impact on economic performance. It is, however, an onerous process and does need to be given time to be appropriately ventilated and vetted to prevent it from being undone in years to come. The last thing our country needs from a fiscal perspective is to have savings on expenditure frittered away by political infighting and the inertia that will inevitably result.Unfortunately, South Africa was battling financial difficulties before the global pandemic struck. The supplementary budget served to confirm the dire state of South Africa’s finances and battled to convince economists and rating agencies of a stable growing economy. In direct response to the emergency budget, Fitch Ratings agency detailed their concerns about South Africa’s ability to stabilize debt in four years. With lower than anticipated revenues and higher than anticipated debt to GDP, there is a tough road ahead for South Africa. In the coming months the government will be faced with tough wage negotiations, strict budget practices, and challenging pandemic conditions under increased debt burdens, we hope to see them navigate these challenges with strong, well defined, forward looking strategies.