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Budget 2016: Ambitious, cleverly crafted but perhaps not enough

The 2016 Budget Review contained ambitious fiscal consolidation targets. Its tone also suggested a strong commitment to growth-enhancing structural reforms. While it is a step in the right direction and has probably bought South Africa some time, the odds of a downgrade by at least one rating agency in December 2016 remain high.

Changes to macroeconomic outlook

As expected Treasury revised down its expectations for economic growth and revised up its inflation forecasts for the next three years relative to what was projected in October’s medium-term budget policy statement (MTBPS).

Economic growth is now expected to average at a more realistic 0.9% in 2016 (MTBPS 1.7%), 1.7% in 2017 (MTBPS 2.6%) and 2.4% in 2018 (MTBPS 2.8%). Treasury remains relatively optimistic about the economic outlook compared to our expectations. Consumer inflation is expected to be above 6% over the next two years.

Stabilising government debt remains the main fiscal policy objective

Against the even weaker economic outlook, government has proposed fiscal policy consolidation that is supposed to lead to a more aggressive deficit reduction path over the medium-term expenditure framework (MTEF) period government’s rolling three-year budget cycle.

The expenditure ceiling has been reduced by R25bn over the next three years compared to what was proposed in the 2015 MTBPS. The additional spending cuts will commence with a R10bn reduction in fiscal year 2017/18 followed by a R15bn additional cut in 2018/19.

On the revenue side, new tax increases are expected to raise gross revenue by R48.1bn over the next three years relative to projections contained in the MTBPS.

For the current fiscal year 2016/17, tax revenue is expected to be R18.1bn higher. Tax revenue is expected rise by R15bn per year for the following two fiscal years.

The consequences of the proposed fiscal consolidation measures will be a stabilisation in government debt at 46.2% of GDP in 2016/17. Debt is expected to decline thereafter.

Compared to projections contained in the 2015 MTBPS, the combined revenue and expenditure steps are expected to lead to additional fiscal consolidation of R18bn in 2016/17, R25bn in 2017/18 and R30bn in 2018/19.

This adds to the R42bn of consolidation measures (R25bn in spending reductions and a R17bn tax increase) announced in the 2015 budget.

Revenue projected to rise by R48bn over three years

Tax revenue for the last fiscal year, 2015/16, is likely to be R11.6bn lower than what was expected in last year’s budget projections.

The lower-than-expected tax revenue collection outcome was due to far lower-than-expected corporate income tax (-R13bn) and VAT (-R5.7bn). Personal income tax collections also underperformed expectations slightly (-R1.9bn). There is likely to be partial offset from an overshoot of R4.3bn in customs duties.

Government proposes several measures to raise tax revenue by an additional R18.1bn in 2016/17. A combination of higher excise duties, the general fuel levy and other environmental levies will raise revenues by R9.5bn.

An increase in capital gains tax and transfer duty will raise revenues by R2bn. Allowing individuals only partial compensation for fiscal drag will account for R7.6bn in additional revenue.

Fiscal drag entails the adjustment of income tax brackets and rebates for inflation so that an individual’s purchasing power remains the same from one year to the next. Providing full compensation for fiscal drag would have reduced tax revenue by R13.1bn. The partial adjustment for fiscal drag amounts to R5.5bn leaving government with R7.6bn in additional revenue.

The details of how the additional R30bn in tax revenues projected for 2017/18 and 2018/19 will be raised will be provided in subsequent budgets following consultation and reviews.

Government has indicated that it will draw on the work of the Davis Tax Committee as part of the decision-making process.

Further reduction in spending ceiling coupled with reprioritisation

The expenditure ceiling has been reduced by a further R25bn over the MTEF period. Spending for the 2016/17 fiscal year is unchanged relative to the 2015 budget and MTBPS projections.

However, spending is projected to decline by R10bn and by R15bn over the next two years.

Government plans to lower its spending ceiling by containing its wage bill. National Treasury has indicated that, starting in April 2016, appointments to fill administrative and managerial vacancies will be blocked on government’s payroll system.

The authorisation of appointments may be considered only after departments have submitted staffing plans that are in line with reduced staff budgets.

Government plans to trim non-critical personnel, eliminate surplus positions and establish a sustainable level of authorised, funded posts.

Besides reducing the expenditure ceiling, government has reprioritised R31.8bn to support new spending requirements.

The reprioritised funds will be used to alleviate pressure in higher education, fund the New Development Bank and top up the contingency reserve.

These funds will be obtained from the savings derived from the wage bill, reduced non-essential operational expenditure and from capital programmes with a history of underspending.

Budget deficit and government debt

The proposed revenue increases and spending cuts are expected to lead to a faster reduction of the budget deficit.

The budget deficit is expected to narrow from an upwardly revised 3.9% of GDP (MTBPS 3.8%) in 2015/16 to 3.2% in 2016/17 (MTBPS 3.3%) declining to 2.4% (MTBPS 3.0%) in 2018/19. Net loan debt is expected to stabilise but at a higher level of 46.2% of GDP.

Is this achievable?

There are several risks that could impede the more aggressive fiscal consolidation path and prevent the stabilisation of government debt at a level below 50% of GDP.

1. Growth is likely to be weaker than Treasury’s forecasts, leading to lower-than-expected tax revenue collection.

2. Distressed state-owned entities may need to utilise state guarantees in order to stay solvent in the short-term and to enable them to execute turnaround plans.

3. While the Treasury has either met or outperformed previous expenditure ceilings, the proposed further reduction in the ceiling targets the wage bill, which government has previously failed to contain within targeted boundaries.

4. Finally, while the tone of the Budget Speech and Review suggested a commitment to pursuing supply-side reforms aimed at improving business confidence and aiding growth, we have heard this before.

Impact on ratings

As a result of the Budget Speech, it is likely that at least one agency will shift a downgrade to sub-investment grade from June to December.

While the proposed fiscal consolidation targets are ambitious, Treasury’s effort was not sufficient to support a conclusion that a downgrade in December is unlikely.

The main reason is that while we are showing renewed commitment, we are probably too late to implement and display evidence of growth enhancing structural reforms in time to save an investment grade rating from all three major agencies.

However, based on evidence from the Budget Speech, we have taken a step in the right direction. That at least prevents further downside, think Brazil!

 *Sizwe Nxedlana is chief economist at FNB.

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