South African Finance Minister Tito Mboweni delivered his maiden Medium-Term Budget Policy Statement (MTBPS) to Parliament on 24 October 2018.
Entitled “South Africa at a Crossroads”, the document admitted that the country’s economic structure is not conducive to high growth and job creation. The rand and bond yields reacted negatively to the statement.
Quoting author Charles Dickens, Minister Mboweni sees the present as the best of times and the worst of times in South Africa. However, he believes that the MTBPS will play a key role in moving South Africa from the crossroads to a new future with faster and more inclusive growth.
The minister’s speech was themed around the five pillars of President Cyril Ramaphosa’s economic stimulus and recovery plan: implementation of growth-enhancing economic reforms; reprioritisation of public spending to support job creation; establishment of an Infrastructure Fund; addressing urgent and pressing matters in education and health; and investing in municipal social infrastructure improvement.
MTBPS has three key priorities:
The MTBPS has three broad priority areas:
- Implementing the economic stimulus and recovery plan launched by President Cyril Ramaphosa in September, with particular focus on infrastructure spending.
- Efforts are being made to improve existing infrastructure spending, including work on a project preparation facility and the planned online publication of expenditure reports on current infrastructure projects. A planned Infrastructure Fund – details will be revealed in February 2019 – is looking for innovative and blended financing options, including private sector money and support from development finance institutions.
- Improving governance and financial management at all levels of government.
- National Treasury’s efforts to improve financial management include collaboration with the Auditor General to reduce irregular expenditure, enhancing public sector management capacity at local government level, the introduction of a framework for more efficient procurement, and development of a framework for the financial recovery of no-performing state departments.
- Reforming State-Owned Enterprises (SOEs) and improving their financial health.
- Reforms include the appointment of new boards at several troubled public enterprises, work by the Auditor General to unearth previously unreported irregular expenditure, forensic investigations into corruption, and a long-term turnaround strategy for Eskom to be revealed in November.
Stimulus plan seen lifting growth over medium term
As expected, the National Treasury revised lower its economic growth forecasts. Due to a technical recession in the first half of 2018, the MTBPS has pared back its growth expectations for 2018 and 2019. Real GDP growth is now expected to slow from 1.3% in 2017 to 0.7% this year, rising to 2.1% by 2020.
Graph: Weaker real economic growth (%) expected in 2018-2019
Source: National Treasury
A growth recovery towards 2020 is premised on the success of the Jobs Summit in creating employment, the Investment Conference stimulating foreign direct investment (FDI), and the economic stimulus and recovery plan supporting growth-enabling reforms and partnerships.
The National Treasury expects these factors, along with support from the Infrastructure Fund and improved investment climate, to lift real investment growth from just 0.1% in the first half of 2018 to 2.1% in the year 2021.
Looking further ahead than the MTBPS framework, the National Treasury estimates that growth-enhancing reforms could lift economic growth be three percentage points – i.e. much closer to National Development Plan (NDP) targets towards 2030 – over the next decade. These reforms include:
- Modernising the energy, water, transport and telecommunications industries
- Addressing distorted patterns of company ownership
- Lowering barriers to entry to stimulate small business growth
- Enabling growth in labour-intensive sectors like agriculture and tourism
- Promoting export competitiveness
- Reducing the cost of business
Underperforming revenues leaves little room for VAT relief
For now, the MTBPS had to deal with pressure on revenues due to a weak economy. The 2018/19 fiscal year (ending March 2019) is expected to see a shortfall in revenue of R27.4 billion compared to what was forecast in February this year. This is both due to weaker-than-expected economic growth (causing underperformance in tax revenue) as well as the clearing of a larger than expected VAT refund backlog.
However, despite these revenue pressures, the MTBPS reaffirmed government’s commitment to maintaining its expenditure ceilings and to achieving debt stabilisation. The Ministry of Finance is also committed to avoid tax increases unless a deteriorated economic environment requires such a move. This is certainly good news and speaks to the confidence government has in the ability of various summits and stimulus plans to revitalise the local economy.
An independent panel appointed earlier this year recommended the value-added tax (VAT) zero rating of white bread flour, cake flour, sanitary pads, school uniforms and nappies. The government has decided to include white bread flour, cake flour and sanitary pads on the list from April 2019. The National Treasury estimates that this will put R1.2 billion back in consumers’ pockets each year.
The MTBPS made no reference to any steps that would address record high fuel prices apart from a pledge that taxes and levies in general will not rise by more than inflation going forward.
Expenditure ceilings hold
Expenditure (as percentage of GDP) is largely tracking the numbers released in February due to the limits placed by expenditure ceilings. However, spending plans do include the reprioritisation of some allocations in order to support policy priorities. For example, funds will be shifted towards townships and rural communities in support of job creation.
Some R32.4 billion will be reprioritised away from underperforming departments over the next three years. In total, more than R50 billion in reprioritisation and in-year changes will help finance the economic stimulus and recovery plan.
Expenditure remains focussed on social needs, with learning and culture, social development and health being the largest expenditure points over the medium term. Debt service costs will grow by the biggest margin (10.9% per annum) followed by learning and culture (8.2% per annum). The latter is associated with the rollout of education funding for students from poor and working class households.
The public sector wage bill (accounting for 35% of total expenditure) was highlighted as a major driver of expenditure pressure following a higher-than-expected wage agreement earlier this year. The Jobs Summit committed to not reducing government staff numbers given the high levels of unemployment already seen in the country.
Table: State expenditure rising to more than R2 trillion by 2021/22
|R billion/percentage of GDP||2017/18e||2018/19f||2019/20f||2020/21f||2021/22f|
|Total gross loan debt||2489.7||2817.7||3038.4||3349.6||3679.9|
Source: National Treasury
Public debt rising as fiscal deficit plans change
Revised revenue and expenditure data for the next few years point to the fiscal deficit deteriorating substantially compared to February’s expectations. A planned narrowing of the shortfall (as percentage of GDP) has largely been abandoned. A deficit equal to 4.0% of GDP in 2017/18 and 2018/19 will be followed by shortfalls of 4.2% of GDP in the following two years.
Graph: Notably wider fiscal deficit (% of GDP) planned over medium term
Source: National Treasury
Funding the fiscal deficit will require some prudent debt management. However, the outlook is far from favourable. The government is planning to expand public debt from R2.8 billion (55.8% of GDP) in the current fiscal year to R3.7 billion (58.5% of GDP). As a result of wider fiscal deficits than previously planned, public debt will now only peak in 2023/24 – a year later than envisioned previously – at 56.6% of GDP.
The majority of borrowing over the medium term will come from the issuance of bonds on the local capital market. The National Treasury has created space for the sale of 5- to 10-year bonds following a recent lengthening of its debt maturity profile. Foreign debt will play a much smaller role in state borrowing by 2021/22 due to risks of rising bond yields and interest rates as well as exchange rate depreciation.
What will the rating agencies say?
Ratings agencies will likely look out for three priority areas that can could trigger changes to the country’s sovereign credit rating in the months after the MTBPS. These are 1) the pace of fiscal consolidation, 2) reforms in state-owned enterprises (SOEs) and 3) measures to lift economic growth.
On the first point, the message is quite clear: the trajectory of the fiscal balance is not narrowing as previously expected. The peak in public debt (a percentage of GDP) is also being pushed out further. The deterioration in deficit and debt numbers has been seen frequently over the past five years, and rating agencies will have to ask the question as to how this may influence South Africa’s credit worthiness going forward.
Regarding reforms to SOEs, there is certainly some positive momentum of late under Minister of Public Enterprises Pravin Gordhan. This includes increased profitability of international routes services by South African Airways (SAA), work on turnaround plans for SAA and South African Express, and the appointment of new boards at several troubled public enterprises.
Economic growth remains a thorny issue. Forecasts for growth in the MTBPS are underpinned by the success of the economic recovery and stimulus plan. Rating agencies will need to make their own projections based on their perspective on the extent to which the stimulus plan will be successful.
Based on these three factors, rating agencies will probably not be too enthusiastic about the MTBPS. It does not suggest any improvement in sovereign creditworthiness. On the contrary, the languishing economy is keeping the government from implementing any real fiscal austerity. As can be seen in the projected figures, this results in rising debt for the state that future generations of South Africans will need to pay for.
PwC Strategy and Economists: Lullu Krugel, Christie Viljoen and Maura Feddersen