/ 22 October 2015

Slow economic growth leaves SA little room to manoeuvre

Finance Minister Nhlahla Nene.
Finance Minister Nhlahla Nene.

It is economic growth that grows tax revenues and it is these revenues that fund development, the finance minister echoed over and over again in his interim budget speech on Wednesday. But in the absence of robust economic growth and subsequent tax income, there is very little fiscal room to manoeuvre and it remains unclear how the South African economy will be revived.

“The resources available to the fiscus – which depends directly on revenues generated by the economy – are expanding too slowly to meet the country’s development requirements,” the medium-term budget policy statement said. 

But there is limited scope for government to incur more debt and some taxes could prove unpopular in the run-up to municipal elections next year, with discontent emanating from a number of quarters in society as evidenced by service delivery and now student protests. 

Government debt to GDP, and the cost of debt repayments, is on an upward trend and has been highlighted as a key concern by credit ratings agencies. (A credit rating downgrade typically means a government is viewed as being a more risky investment and so its cost of borrowing increases). Growing at an average annual rate of 10.9%, debt repayment is now government’s fastest growing expense. 

Weak economic growth now means that projected debt levels are revised marginally higher and gross loan debt is expected to rise from 46.8% of GDP at present to 49.4% by 2018/19. 

After the last recession money was pumped into the economy, and helped to fatten up public sector employment, and as a result debt grew to GDP from 26% to 46.8% at present. 

Government remains a fan of counter-cyclical measures and, in treasury’s policy statement, it stood firm in its conviction that, in times of low growth spending needs to increase. 

Kevin Lings, chief economist at Stanlib, said: “Government hasn’t been able to make the progress they wanted and had to revise debt levels higher. It’s not at a point that it is critically high, but it is at a level where it is concerning.”

Lings noted that the jump in the value of debt was partly attributable to the fact that the portion of debt which is foreign had increased in line with the weakening value of the rand. 

Ratings agencies have loosely indicated they are concerned with about 50% government debt. Internationally, 60% debt is the broad guideline. 

Emerging market analyst at Nomura, Peter Attard Montalto, said the budget assumes too high a level of nominal GDP growth in the outer two fiscal years, as well as too constrained a level of debt service costs. “On the positive side,” he said. “The expenditure ceiling was kept in place and further tax hikes were proposed.”

The medium-term budget policy statement showed that tax revenue targets were revised downward by R7.6-billion for this financial year and by R35-billion over the medium-term. Personal income tax and VAT performed well, but corporate income did not due to the steep decline in commodity prices and the slowdown in economic activity.

Increases or a widening of the tax base would seem inevitable. But there was little indication of any reforms that might be ready to go by February, although the policy statement notes additional taxes are “essential to fund government’s ambitious policy agenda” in the context of weak growth. 

Such taxes will however be approached with caution, it said.

For one, the long-debated carbon tax will be subjected to further debate.  While minister Nene told media that the door for a VAT increase was always open, analysts believe that real consideration of such a politically-difficult tax would likely be delayed beyond next year’s elections.  Nene said he had further advice on a wealth tax which has been mooted by organised labour and, most recently, by world-renowned economist Thomas Piketty in recent talks held in South Africa. 

Commenting on the mini-budget, emerging market analyst at Nomura, Peter Attard Montalto, said: “there is enough here to avoid a downgrade by Moody’s right now; however, with such a strong set of downside risks to next year’s growth, a downgrade still looks likely. The fiscal-related hurdle to an S&P downgrade to junk is still too great.”

Debt levels are not the only risk there are a number of others exacerbated by lack of economic growth, said Lings. “When you put them all together with social overlay, it increases the chance that Fitch [ratings] acts on its negative outlook.”

While the budget deficit could be argued as a sort of stimulus already, Lings said, government’s hands are tied and it cannot embark on a fresh new stimulus. “If it did it would push debt levels too high and it would trigger a downgrade.”

Government should be asking itself harder questions about how does it spend its money and what does it get out of what it spends, said Lings. Investing in consumption expenditure would not provide the sustainable job creation that is needed.