/ 26 October 2016

Mid-term budget wrap: Spending cuts, tax increases to compensate for slowing economy

Medium Term

As South Africa faces many unknowns, Finance Minister Pravin Gordhan presented a cautious medium-term budget policy statement on Wednesday, tailored for an economic environment that is “a challenging one, but not an impossible one”.

Some of those unknowns are: Will economic growth pick up or slow? Is a credit rating downgrade coming in December, and, if it happens, how will it affect the South African economy? What unexpected demands might arise, placing further pressure on the tax coffers? And, come February next year, will it be Gordhan delivering the budget speech?

The medium-term budget policy statement (MTBPS) is a government policy document that communicates to Parliament and the country the economic context in which the forthcoming budget will be presented, along with fiscal policy objectives and spending priorities over a three-year period.

Quite simply, the economy has slowed and so tax revenues have fallen short of expectations. To plug the widening shortfall, spending must be further cut and taxes must be raised.

Without a change in policy, the expected budget shortfalls are R36-billion and R52-billion in the next two years, respectively.

Following a series of expenditure cuts, the medium-term budget policy statement proposes a further R26-billion in reductions to the public expenditure ceiling over the next two years.

New proposed tax measures amount to R13-billion in the 2017-2018 financial year. Combined with the higher taxes signalled in the 2016 budget, total revenue increases will amount to R43-billion over the next two years.

The higher taxes outlined in the 2016 budget comprised higher excise duties, an increase in the fuel levy and other environmental taxes, and adjustments to capital gains tax and transfer duty. Allowing for higher income earners to shift into a higher tax bracket would also contribute to the fiscus.

But in a press briefing on Wednesday Gordhan refused to be drawn on how more tax revenue might be raised. “We don’t discuss tax choices in the MTBPS,” he said.

With a great deal of pressure on the budget, Gordhan said spending will be sustained on core priorities and existing resources will be shifted to critical needs.

Higher education

One priority is the funding of higher education.

The demand for free higher education has persisted, and chaos has erupted at campuses across the country as police have clashed with protesting students.

Allocations to post-school education and training are now the fastest growing element of the budget, after debt servicing costs. Much of this growing budget has benefited vocational colleges and other training funds and entities, rather than universities.

Still, the treasury said subsidies to universities will grow at 10.9% each year and transfers to the National Student Financial Aid Scheme (NSFAS) will grow at 18.5% Universities and students will now receive an additional R17-billion over the medium term.

In 2017, the government will fund a fee increase at higher learning institutions of up to 8% for students from households earning up to R600 000 per year. NSFAS will also receive significant top-ups.

Speaking alongside Gordhan at a press conference on Wednesday, Minister of Higher Education Blade Nzimande said he was happy about the allocations the treasury had signalled. But he said the college sector needed to be up to four times larger than the university sector. He also said money alone would not solve the problems faced, such as poor throughput rates.

Gordhan said a number of technical proposals had been received, the best of which suggested solutions that would complement the limited state resources. They had provided an indication of how some of the problems facing students could be solved immediately, he said.

Try as he might, the political context in which Gordhan presented his budget could not be ignored.

Seemingly trumped-up fraud charges brought against the minister by the National Prosecuting Authority – for his role in granting early retirement to a South African Revenue Services official – are due to be aired in court next week. The charges have stoked fears that a more sinister plan to replace the minister, with an aim to loot state coffers, is at play.

Gordhan wished only to field questions related to the MTBPS on Wednesday, but injected a quip about possibly being in the job market sometime soon.

Flanking the minister at the briefing, Deputy Finance Minister Mcebisi Jonas noted that political stability was paramount in order to foster investor confidence.

The MTBPS is the last opportunity for Gordhan to demonstrate to credit ratings agencies that South Africa is making progress and does not deserve a downgrade come December (when the agencies will reassess the current rating).

A lower rating signals a higher investment risk. This can prompt a higher cost of borrowing for a country, as well as large capital outflows.

Drivers of growth remain a key concern. In the February budget, the treasury’s economic growth forecast for this year is 0.9% but in the policy statement this is revised to 0.5% – more optimistic than estimates by others such as the International Monetary Fund.

The budget deficit is estimated to continue on a narrowing trajectory and the gap will taper from 3.4% in this financial year to 2.5% by 2019-2020. Total loan debt will remain under the key 50% threshold over the medium term, reaching 47.9% in 2019-2020.

The treasury is optimistic that an economic recovery is emerging, as factors that were limiting economic growth are receding.

There has been a slight rebound in commodity prices, drought conditions have eased, and electricity constraints are no longer an issue.

This year growth of 0.5% is expected, according to Reserve Bank and treasury projections. Next year a 1.3% improvement in annual growth is forecast, and growth of 2% and 2.2% is estimated for 2018 and 2019 respectively. Headline inflation is expected to slow from 6.4%, as estimated for 2016, to 6.1% next year, and to 5.9% in 2018.

But the policy statement shows the treasury is also not counting out a number of other scenarios in which low growth persists.

The risk here is that South Africa could fall into a low-growth trap if fiscal consolidation is not balanced. In a low-growth trap, low economic growth means lower tax revenues. Aggressive steps to stabilise debt and contain the budget deficit may bolster confidence but could undermine the economy.

The treasury’s modelling indicates that if the trend rate of economic growth remains below 2% for an extended period, the “government will not be able to sustain its current policy commitments”. Tough trade-offs will have to be made. Limited space to increase taxation cannot accommodate proposals and large spending commitments related to health, education, defence, social development and infrastructure.