Budget 2016: More revenue a must for South Africa to avoid junk status
Finance Minister Pravin Gordhan's budget, to be delivered on February 24, needs to show real improvement in both fiscal expenditure and revenue if South Africa is to avoid being downgraded to junk status, cautioned two economists at MMI.
MMI Investments and Savings economist Sanisha Packirisamy warned on Thursday that structurally high expenditure and a cyclical slowdown in revenue growth pose a significant threat to the country’s sovereign debt ranking. The absence of an improvement in debt metrics is likely to trigger a ratings downgrade by the December review - or even as soon as the June review - if the budget disappoints, said Packirisamy.
She shared the view of Herman van Papendorp, head of macro research and asset allocation at MMI, that bland growth expectations, characterised by lacklustre growth in domestic demand, tepid global trade activity, labour unrest and stuttering electricity supply, will likely put hurdles in government’s ability to meet the tax revenue collection targets set in October 2015's mini budget.
Van Papendorp and Packirisamy pointed out that current expenditure would have to be curtailed meaningfully to protect the expenditure ceiling, while limiting cutbacks to vital capital expenditure. Revenue-enhancing tax proposals would also have to be part of the mix to bring down the deficit in coming years.
In their opinion, a likely dent to tax revenues will require a higher tax burden and sizeable cutbacks on expenditure plans, including non-essential goods and services, capital expenditure and the contingency reserve.
In the national budget delivered in 2015, government reiterated that tax policy aims to raise revenue in a fair and efficient manner that supports long-term economic growth and job creation. To achieve this, it has attempted to broaden the tax base over the past two decades.
"In addition to the standard fuel, 'sin' taxes and bracket creep, additional revenue measures may have to be considered in the 2016 budget," warned Packirisamy.
"Although the backdrop of a slowing growth environment - particularly in a local government election year - challenges a decision to raise consumption taxes on a broader base rather than increase the tax burden on higher-income earners, Treasury may have little choice but to deliver on both in order to improve the fiscal trajectory and appease rating agencies."
President Jacob Zuma's State of the Nation speech (SONA) addressed the economic threats facing SA and admitted to not acting quickly enough in the past. But government did not provide measurable targets for cost-cutting initiatives affecting non-core services. Packirisamy believed SONA outlined few tangible proposals to resolve regulatory barriers.
"In our view, little was said to increase faith in government’s ability to accelerate anaemic domestic gross domestic product (GDP) projections, while simultaneously averting a sovereign debt downgrade to junk status over the next year."
It seems to them that the task of providing detailed plans on this has been left to the finance ministry during the delivery of the National Budget.
In response to pressure on government from business and rating agencies, Zuma has since released a report that recommends a shake-up of SA’s state-owned enterprises (SOEs), including a partial listing of some and the privatisation of others.
The report recommends encouraging and expanding private sector participation through partnering with SOEs to deliver on economic and social infrastructure plans. In addition, an interministerial committee is currently investigating how to instill good corporate governance across SA’s SOEs and prevent the practice of awarding contracts on the basis of political connections.
The vulnerable financial state of parastatals could prompt a further extension of Treasury’s guarantees, preventing the stabilisation of the overall debt ratio - including guarantees, provisions and contingent liabilities - below the 60% South African Development Community (Sadc) target, warned Packirisamy.
Treasury’s February 2015 projections estimated overall debt reaching 58.1% of GDP by the financial year 2015/2016, with contingent liabilities accounting for R485 billion - close to a fifth of the total value of debt projected at R2.4 trillion.
SAA racks up a R29 billion bailout
Packirisamy pointed out that South African Airways (SAA) has been a key risk in the SOE space, racking up close to R29bn in bailout funds, loan guarantees and convertible loans since the financial year 2004/2005.
"Although Treasury avoided making pre-delivery payments to Airbus - which would have amounted to R603m - and have instead finalised a swap deal, all eyes will remain on the appointment of a new permanent SAA board to stabilise the airline," said Packirisamy.
"Improving cooperation between public and private sectors in infrastructure development should be viewed positively, but more concrete measures will need to be announced in the budget to prevent growth in investment from stagnating."
Fitch downgraded both SA’s local and foreign currency debt by one notch in December 2015, while also attaching a neutral outlook to the ratings. S&P affirmed both its ratings in December, but revised the outlooks to negative. Moody’s also dropped its outlook on SA’s debt to negative in December 2015.
Packirisamy pointed out that since then, the growth outlook has deteriorated further, putting more pressure on fiscal and debt metrics, particularly relative to the BBB-ratings peer group. Additionally, mounting debt risks associating with contingent liabilities and escalating debt servicing costs - as a share of government revenues - lowers SA’s fiscal flexibility.
"One of the historical cornerstones of SA’s investment-grade rating has been its highly-regarded institutional framework, including the Treasury and the SA Reserve Bank. Nenegate has introduced worries that these institutions are no longer deemed untouchable by politicians and could be less independent institutions than previously perceived," concluded Packirisamy.