South African budget 2019/2020 review
You have to hand it to Tito Mboweni, he was dealt some pretty bad cards and did the best he could in the 2019/2020 budget. He had to walk a fine line between saying something the rating agencies wanted to hear, avoid killing growth completely and at the same time appease the unions (so that they still support the ANC in the coming election).
On that score he probably disappointed the rating agencies the most, but as he was heard to say – when it comes to the rating agencies, we are damned if we do, damned if we don’t. South Africa has no choice but to help out Eskom, but at the same time this leads to increased debt for the Fiscus. In reality it could have been even worse, so for now we stick to our view that the budget was the best hand he could have played.
The best line from his budget speech has to be the following, as it speaks volumes of the Herculean task ahead of us in this country today, after years of blatant theft and mismanagement. “In October, I quoted A Tale of Two Cities by Charles Dickens. After a few months in the role, I feel that Oliver Twist might be more appropriate this time. In short, ‘Please, sir, I want some more.’”
So, in that vein, here are some of the key takeaways from the budget – where the “more” is coming from and where it is going.
Tax rates have stayed the same from the 2018 budget, with the key factor being that the tax brackets have not been moved up to alleviate inflation increases. Given that the majority of people in South Africa who received above inflation increases at the beginning of this year probably work for the Government, essentially the Government has given state employees a salary increase and then asked for part of it back in higher taxes. Keeping tax brackets static should raise a further R12.8 billion in revenue, plus a further R2 billion from a carbon tax and excise duties.
The reality is, as we commented last year and highlight again, a government can only increase taxes so much until people revolt against it and as the graph below shows, gross tax revenues as a percentage of GDP have been falling, even after last year’s tax increases, as taxpayers simply refuse to pay up. Scarily we are also hearing that one of the other reasons for this fall was emigration, as high-end tax payers have left the country in their highest numbers since the ANC first came to power.
Gross Tax Revenue as a percentage of GDP
*2018/19 is an estimate Source: National Treasury
The “more” is going to Eskom, to which Tito has promised another R69 billion over 3 years, but he made the following point, which I think speaks volumes about the Government’s tougher line on State Owned Enterprises:
“Pouring money into Eskom in its current form is like pouring water into a sieve. I want to make it clear – national government is not taking on Eskom’s debt. We are setting aside R23 billion a year to financially support Eskom during its reconfiguration. It will cover Eskom’s interest payments. All other savings will need to come from revenue increases and efficiencies”.
Given that the president has promised no job losses, this is not going to be an easy task!
Expenditure (the more) is forecast to rise more than originally projected because of extra allocation to Eskom and given that expenditure is higher than revenue for the foreseeable future, budget deficits are forecast to rise from 4.2% of GDP in 2018/2019 to 4.5% in the 2019/2020 year, “recovering” to 4% in 2021 – all of which leads the Debt-to-GDP ratio to rise to over 60% in 2023/2024. This is something the rating agencies will be watching and given that this is higher than expected by the market, it could put SA at a higher risk of a ratings downgrade.
On that note, Moody’s did comment that: “The budget shows a further erosion in fiscal strength after the October medium-term budget policy statement already pointed to wider deficits for longer.” They also noted limited fiscal flexibility in a challenging economic environment. This is code for, a downgrade is now more likely as it doesn’t seem the Government has much negotiating room with the unions.
So, in a nutshell, it was a budget that showed revenues are falling and expenses are rising, leading to Debt-to-GDP levels rising above 60%. Clearly this is not something we all wanted to hear, but after the rampant corruption and state capture over the last 10 years, the chickens have come home to roost.
The positives from the budget are that the Government is not willing to keep writing blank cheques, it is questioning the need for a number of State Owned Enterprises and is starting to talk tougher than we have seen in years. Implementing this budget is going to be the hardest part, especially if the labour unions refuse to play ball, but as Pravin Gordhan said on Bloomberg this morning, if they do not come to the party over Eskom, an awful lot more people in this country are going to lose their jobs. He was also more upbeat on the downgrade, arguing that Moody’s can see the positive steps we are taking to root out corruption and restore credibility to government finances.
However, the budget was still very sketchy on how growth is going to be created and this is something that Moody’s really needs to see. The downgrade is very hard to call, with this budget certainly not alleviating those risks. But as far as bond markets are concerned, with inflation falling to 4%, any downgrade will lead to a buying opportunity on SA bonds. For now, we are sticking to our flexible income managers, who are investing more at the short end of the curve – i.e. not taking much interest rate risk.