SOUTH AFRICA's 2013 Budget presented by finance minister Pravin Gordhan was like a snapshot of a car on a hill with its handbrake off – seemingly still and fixed to the ground, yet actually at great risk.
On the surface things are calm. But look ahead and there are serious dangers on the road ahead.
In 2012 the government offset some revenue underperformance resulting from strike action and lower growth projections by underspending on capital investments and dipping into the contingency reserve. The rhetoric of belt-tightening and little room to manoeuvre was welcome.
All this has meant a wider deficit forecast in the near term – out to -5.2% of GDP in the current fiscal year from -4.8% previous and a deterioration of 0.1 percentage point of GDP next year, but ministers still plan a consolidation programme aiming at cutting the deficit to 3.1% in 2015-16. However, this comes with higher borrowing requirements and debt much higher than the treasury has ever admitted was a risk. The National Treasury now see debt rising to 44.6% by start 2016 compared with their previous forecast of 42.7%.
None of this is a surprise and is broadly in line with market expectations. However, it will likely ring alarm bells in rating agencies – especially if combined (as we expect) with a re-escalation in labour violence and strike action through Q2 and Q3 2013.
But how there can be such a fast pace of consolidation between the next fiscal year and 2015-16, when growth is slower and public expenditure has not changed much?
There seems to be a reliance on a marked increase in the capacity of economic growth to generate higher tax revenues (multiplier effects) that we do not think is possible. The minister claims that over the next two decades the amount of budget revenue can double if GDP growth breaches the 5% target in the National Development Plan and thus allow for greater spending.
However, as additional expenditure requirements are coming much faster than that 20-year outlook the minister mentioned – national health insurance, faster infrastructure spend, additional spending on public sector wages likely prompted by possible strike action – there is a large hole in the expenditure side of the budget.
The National Treasury recognises this, and the government is currently analysing long-run expenditure reports as a conservative National Treasury battles with more spendthrift members of the wider government and the politically-motivated demands of the ruling ANC.
This is where a revenue commission as announced by President Jacob Zuma comes in. This commission, which should report at the end of the year, will examine whether revenue policies are fit for the expenditure challenges they face.
Such a commission will be worthless if it considers only the unrealistic scenario of growth reaching the fabled 5% over the long run, and should look at a much more realistic scenario that current potential growth is only around 3.7% and is likely to rise only slightly over the medium run.
Reaching the ‘potential-potential’ growth figure we estimate at 5.0-5.5% over the long run would require a much larger wholesale implementation of the National Development Plan, especially labour law reforms, a larger infrastructure programme and a step change in FDI and competitiveness (especially improving education).
The commission should, under the right remit, highlight the need for greater revenue via increasing the tax base and tax rates. Since it is now ANC policy, it seems impossible for the government to reject a mining super-tax.
Personal and corporate tax rates will also likely be recommended to rise, particularly to form part of the funding ‘wrapper’ for national health insurance.
However, fundamentally we envisage such a commission’s work being used to support higher spending – with only limited consideration being given to supporting lower debt levels and faster fiscal consolidation.
While, policymakers now recognise belt-tightening is needed – and there are R10.4bn of cuts within the budget – we think new additional revenues would not be used to make savings. Hence, high bond issuance forecasts from the Budget would remain.
At the same time the National Treasury presents a very bearish view of the current account, basically seeing the deficit stuck at 6% of GDP out to 2015, which highlights South Africa’s current poor competitiveness.
This ties in with this week’s record-breaking trade deficit of R24.5bn in January alone. Such a twin deficit, when combined with the prospect of further ratings downgrades and a high level of foreigners holding domestic treasury debt, highlights the very large risk that the government is running by proposing a slow, debt-funded pace of fiscal consolidation, as well as pushing electricity generator Eskom to issue more debt and cut household tariffs.
We see this scenario as sustainable only if the current deluge of money continues flowing into emerging markets – and South Africa is benefiting from this too, even if sovereign risk worries mean investors are establishing an underweight position.
However, by the end of the budget horizon in 2015-16 we should be in a very different world with much tighter global monetary conditions. While we don’t expect large EM outflows at that time, the lack of new inflows to finance the huge twin deficits is the real risk for South Africa.
The only solution we see, barring an unlikely miracle of a success in boosting competitiveness, is much higher taxes to plug the funding gap, a much weaker rand and higher interest rates.
This should surely be enough to push the government into rapidly pressing ahead along the path laid out in its National Development Plan. The political pressures to move in this direction have increased, but not enough in our view. Markets may have to provide a strong nudge.
*Peter Attard Montalto
is a director and emerging markets economist at Nomura. Views expressed are his own.
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