Budget 2019: if only the numbers could live up to the narrative
Finance Minister Tito Mboweni’s maiden Budget Speech two weeks ago has by now been thoroughly dissected by commentators across the economic and political spectrum. In our view, it didn’t amount to much more than a policy document – setting out how government intends to balance or manage conflicting interests, while at the same time applying fiscal prudence. While the narrative looks promising, the numbers remain deeply concerning – and the margin of error too small for comfort.
It was clear during the Medium-Term Budget Policy Statement (MTBPS) in October last year that the then newly appointed Finance Minister had taken on an unenviable job in terms of getting South Africa back on a road of fiscal sustainability. All the important fiscal ratios were pointing in the wrong direction while at the same time, ordinary South Africans were urgently demanding improved service delivery.
Four months on, not much has changed. The local economy is struggling to grow at a rate faster than consumer inflation, the Eskom debacle (or rather, disaster) is tangible, and the numbers are frightening. To top it all, we have a general election looming – voters go to the polls in May.
Minister Mboweni thus had to present his first Budget Speech to Parliament in a challenging economic and political environment. Leading up to the event, we all speculated whether he would be brave enough to address the obvious overspending on government consumption to reduce expenditure in relation to gross domestic product (GDP) to ultimately stabilise government debt levels in 2023/24.
Beyond the crossroads
Our colleague at Sanlam Investments, Investment Economist Arthur Kamp, highlighted that ‘history suggests that the ability of governments to reduce expenditure relative to GDP is especially important in fiscal adjustments’. In this regard, during the first nine months of the 2018/19 fiscal year (FY), Treasury performed admirably in containing expenditure growth. Nonetheless South Africa is still moving beyond the crossroads – and the 2019 Budget was expected to provide important clues as to which path Treasury has chosen. At the very least, government support for the balance sheets of state-owned enterprises (SOEs) needs to be accompanied by a credible plan for the turnaround of these entities.
Our interpretation of the narrative in the Minister’s speech is that he has clearly acknowledged these challenges. First, the meaningful turnaround after the earlier expansion of the government’s wage bill is significant. National and provincial compensation budgets will be reduced by R27 billion over the next three years. Second, while many commentators were disappointed by the Eskom allocation of R23 billion a year for the next three years during its reconfiguration, the funding support comes with ‘strict conditions’. These include the appointment by the Ministers of Finance and Public Enterprises of a chief reorganisation officer with a mandate to deliver on the recommendations of the presidential task team – and a recommendation of similar interventions for other SOEs that request guarantees for operational expenses.
Fiscal slippage disappointing
However, the numbers in isolation don’t make for good reading. Unfortunately, the fiscal slippage remains disappointing. The main budget deficit forecast has worsened to 4.7% from 4.4% in the MTBPS for FY 2019/20 and from 4.3% to 4.5% for FY 2020/21. The crucial number – the gross debt-to-GDP ratio – deteriorated from 58.5% to 58.9% in FY 2021/22. It’s still forecast to stabilise in 2023/24, but at a slightly higher level of 60.2%. This slippage can be ascribed mainly to the larger-than-expected R69 billion injections into Eskom. If measures to cut expenditure on politically sensitive government wages fail, one may well find that the goal to stabilise net debt-GDP around the 60% levels is again simply a pipe dream.
Our country’s fiscal woes were also noted by rating agency Moody’s, scheduled to formulate its view on the credit rating for South Africa’s foreign debt on 29 March this year. In a statement shortly after Minister Mboweni’s speech, the agency said this year’s Budget showed a ‘further erosion in fiscal strength’ and highlighted the government’s ‘limited fiscal flexibility’.
Funding of expenditure remains troublesome at a time when economic growth remains scarce. Tax revenues have underperformed mainly due to weak growth and impaired tax administration. Revenues for 2018/19 are expected to be R15.4 billion lower than the MTBPS forecast. Half of the shortfall is due to higher‐than‐expected VAT refunds. Unlike last year when the increased VAT rate was expected to net additional revenue upwards of R20 billion, the combined additional revenue measures for 2019/20 will bring in only R15 billion. Unfortunately, individuals will again have to bear the brunt to make up for the shortfall, contributing an additional R13.8 billion – achieved mainly by leaving personal income tax brackets unchanged and not fully adjusting thresholds for inflation.
Seen purely from an investment perspective, the 2019 Budget is unlikely to lift the spirits of local equity investors. It is restrictive. The significant fiscal drag across the income spectrum, which government expects will be worth around R12.8 billion, or around 0.4% of total annual household consumption expenditure, is likely to put further pressure on consumer spend. Planned savings on government salaries won’t help either. The Minister did highlight that the infrastructure fund is a central pillar of reprioritisation, and government has committed R100 billion to it over the next decade. However, total infrastructure spending forecasts have been trimmed as a result of lower SOE spending estimates.
The deterioration in fiscal numbers should also concern bond investors. The increase in funding needs will require a marginal increase in local bond issuance compared to previous estimates. Increased supply usually has a negative impact on the price of bonds.
Moody’s will certainly interpret the Budget from a qualitative perspective when it considers a possible change to South Africa’s sovereign credit rating. The rating agency will likely take into account that support for Eskom has worsened the credit metrics only marginally (on paper). The reduction in the wage bill will be a noticeable step forward in addressing one of the major weaknesses in South Africa’s general fiscal slippage in recent years. It’s therefore unclear whether the fiscal deterioration will be sufficient to tilt the odds towards a downgrade. In all likelihood, Moody’s will at least downgrade the outlook for the South African economy.
In a nutshell
All in all, the narrative of Minister Mboweni’s Budget Speech does provide some hope – he’s demonstrated a clear understanding of the fiscal challenges facing our country. He’s also offered solutions on paper to address some of the major obstacles en route to fiscal sustainability. However, the numbers suggest that the margin for error is small. And should the political will to address the drag that non-performing SOEs are placing on the fiscus be lacking, this margin may not be large enough.