Joanne Baynham - MitonOptimal South Africa - Pulling a rabbit out of the South African hat?In what many consider will the last of his budget presentations, South Africa’s Finance Minister Malusi Gigaba, who is accused of state capture and rumoured to be one of the cabinet ministers who will soon lose his job, presented a surprising and far better than expected budget. Within that budget, he increased Value Added Tax (VAT) from 14% to 15%, effectively raised income taxes (by not increasing the income tax bands) and also raised estate duty. But, the bulk of new expected revenue is based on an increase in VAT receipts.

In terms of the income side of the equation, it was not what Gigaba did, but what he did not do that surprised the market. Capital gains taxes were not increased, nor too was the 45% tax rate for high-income earners, both increases had been highly anticipated.

South African personal income tax is running close to 10% of GDP, relative to a developed markets average of 8.4%, and even lower in developing markets. Given that, one can only assume that the South African government realises that there was very little scope to push income taxes much higher, exacerbated by the fact that compliance by taxpayers has been deteriorating over the last couple of years.

This is commonly referred to as ‘tax buoyancy’, where a level greater than one means taxes are growing faster than GDP, and a level less than one means taxes are growing less than GDP. Last year, South Africa saw that number come in at 0.96, which could potentially explain the reluctance of the government to increase personal income taxes much further.

Interestingly, part of the reason for the budgeted increases in taxes, for 2018 and onwards, is that this buoyancy should improve and taxpayers will hopefully go back to being more compliant. This might be a big ask, but with an expected shake-up at South African Revenue services and a new feel-good factor, thanks to the new President Cyril Rhamaphosa, this may yet be achievable.

The most positive part of the budget was a commitment to try and cut expenditure, with the intention of reducing overall spending by R85.7 billion over the next three years, with the tabled increases in spending on specific items, such as the national health system and student fees, being allocated from other parts of the budget.

However, one does need to note that right now, overall expenditure is still expected to increase by 7.6% per year for the next three years, so one can only hope that the forecast cuts do actually happen or expenditure will potentially balloon.

The government has also increased their growth projections over the next three years, with growth expected to exceed 2% in 2020. Sadly, that number that is still far too low to generate jobs for all South Africans, but at least for now is a step in the right direction. If President Rhamaphosa achieves his goals of rooting out corruption and encourages a more business-friendly environment, those growth targets might be on the conservative side.

This was never going to be a popular or easy budget for the Malusi Gigaba to deliver, especially after years of mismanagement under Zuma’s reign, but under the circumstances, it was far better than the markets were expecting and a considerable improvement on expectations announced by Treasury in October of 2017. By increasing VAT revenue and attempting to curtail expenditure, the Debt to GDP ratios is now forecast to fall to 56% by 2022, versus the 60.8% previously budgeted forecast in October 2017.

There is now also hope that Moody’s will not downgrade SA’s local debt when they next meet, as this budget shows a clear intention to try to be more fiscally austere while attempting to not undermining growth. The budget also highlighted less demand for new issuance of bonds, and as can be seen in the graph below, the SA bond market was undoubtedly cheered by all of this news.

Weekly Comment Bloomberg Chart - Pulling a rabbit out of the South African hat?

In a nutshell, this was a far better than expected budget, but a lot of the assumptions on growth and cost-cutting may be a bit too optimistic. It is early days for President Rhamaphosa, but if private enterprise and government can start to work together instead of being at loggerheads, as they have done over the last few years, there is a very real hope that these budgeted forecasts can be achieved.

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