Bad news for higher income tax payers

2017-02-28 17:58
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Cape Town - Despite a higher marginal income tax rate of 45% being introduced on taxable income over R1.5m, the National Budget maintained fiscal prudence.

This is according to Overberg Asset Management in its weekly overview of the SA economic landscape.

The Budget Speech, delivered by Finance Minister Pravin Gordhan last week, stuck closely to the guidelines set out in October’s Medium-Term Budget Policy Statement, noted OAM.

The budget deficit will reduce from an estimated -3.4% of GDP in the 2016/17 financial year to -3.1% in 2017/18 and -2.8% in 2018/19.

The 2017/18 budget deficit will raise an additional R28bn equivalent to around 0.5% of GDP, from a combination of higher income taxes, an increase in the dividend withholding tax from 15% to 20% and higher indirect taxes on petrol, tobacco and alcohol.

South Africa economic review

• While bad news for higher income tax payers and for equity investors, the budget maintained fiscal prudence despite a difficult economic backdrop and extreme political pressure. The primary budget, measuring the difference between income and expenditure net of interest payments, has reduced steadily from -1.6% of GDP in 2012/13 to an estimated -0.5% in 2016/17 and projected to be in surplus at 0.2% of GDP in 2018/19.

Total government debt has increased to 50.7% of GDP but is projected to decline below 50% over the next three years. Successive three-year budget ceilings first introduced in 2013 have been successfully adhered to, and a further R11 billion in expenditure has been cut from the current year’s budget.

Furthermore, the budget has allocated another R947.2 billion in infrastructure spending over the next three years, equivalent to a healthy ratio exceeding 6% of GDP. (See Bottom Line for further analysis).

• Producer price inflation (PPI) decelerated sharply from 7.1% year-on-year in December to 5.9% in January its lowest reading since December 2015. The decline is attributed to a decrease in food price inflation from 12.2% to 10.6%, while transport equipment inflation plunged from 2.1% to -4.3%.

Metals, machinery, equipment and computing equipment inflation also enjoyed a substantial drop from 5.95 to 3.0%. PPI is expected to maintain its downtrend during 2017 as food price inflation continues to moderate in line with better crop yields.

• The South African Reserve Bank (SARB) leading indicator, which projects economic conditions 3 to 6 months ahead, increased from 95.6 in November to 96.3 in December its fifth straight monthly gain, taking the reading to its highest since the fourth qurater 2014.

The rise was led by an increase in the lead indicator of South Africa’s trading partners followed by an increase in the country’s dollar-based export commodity price index. The steady gain in the leading indicator indicates the worst of last year’s economic slowdown is past and that growth should pick-up in the months ahead.

The week ahead

• Trade balance: Due Tuesday 28th February. The trade balance is expected to return to deficit in January following the substantial R12bn surplus in December.

A trade deficit typically occurs in January as imports resume following the seasonal decline during the festive season. However, the January deficit is likely to be smaller than in previous years due to constrained local demand.

• Private sector credit extension: Due on Tuesday 28th February. Growth in private sector credit extension (PSCE) is expected to pick-up slightly in January from the 5.1% level recorded in December, in line with a modest increase in GDP growth.

While corporate lending is rising in line with the gradual recovery in business confidence household credit demand remains constrained by weak jobs growth and high levels of indebtedness.

• Manufacturing PMI: Due on Wednesday 1st March. The manufacturing purchasing managers’ index (PMI) for February is expected to remain above 50, denoting expansion, showing a similar reading to January’s 50.9 level. Market conditions in the allied mining and agriculture industries are showing a steady recovery while external demand is steadily improving.

Technical analysis

• While the rand has broken below key resistance levels versus the dollar at R/$ 13.20 and 13.00 the strengthening trend is not confirmed by momentum indicators, signalling that the currency is overbought.

• The US dollar index is testing a major 30-year resistance line, which if broken will pave the way for further strong gains in the currency.

• Following the Brexit vote the British pound hit its weakest level against the US dollar since 1985. The key £/$1.25 level support level has been broken opening up a £/$1.18-1.22 target.

• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.

• The US 10-year Treasury yield has broken back above the key support level of 2.0% endangering the multi-year bull trend in US bonds.

• The benchmark R186 SA Gilt yield is now testing the key support level of 9.0% endangering the mini-bull market in bonds which has been in place since the start of the year.

• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdqaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.  

• The Brent crude price is well supported at $50 a barrel and having broken key resistance at $55 is targeting further gains to the next key level at $60. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $5500 per ton.

• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1400 target level.

• A break above 54 200 on the JSE All Share index would project an upward move to 60 000 marking a new high for the JSE.

The bottom line

• The State budget stuck closely to the guidelines set out in October’s Medium-Term Budget Policy Statement. The budget deficit will reduce from an estimated -3.4% of GDP in the 2016/17 financial year to -3.1% in 2017/18 and -2.8% in 2018/19.

The 2017/18 budget deficit will raise an additional R28bn equivalent to around 0.5% of GDP, from a combination of higher income taxes, an increase in the dividend withholding tax from 15% to 20% and higher indirect taxes on petrol, tobacco and alcohol. A higher marginal income tax rate of 45% was introduced on taxable income over R1.5m.

• While bad news for higher income tax payers and for equity investors, the budget maintained fiscal prudence despite a difficult economic backdrop and extreme political pressure. The primary budget, measuring the difference between income and expenditure net of interest payments, has reduced steadily from -1.6% of GDP in 2012/13 to an estimated -0.5% in 2016/17 and projected to be in surplus at 0.2% of GDP in 2018/19.

Total government debt has increased to 50.7% of GDP but is projected to decline below 50% over the next three years. Successive three-year budget ceilings first introduced in 2013 have been successfully adhered to, and a further R11bn in expenditure has been cut from the current year’s budget.

Furthermore, the budget has allocated another R947.2bn in infrastructure spending over the next three years, equivalent to a healthy ratio exceeding 6% of GDP.

• Finance Minister Pravin Gordhan espoused a more “radical” approach to economic transformation but insisted that this could not come at the expense of fiscal responsibility. In his budget speech Pravin Gordhan stressed: “Let me say clearly and emphatically: sound public finances, the health of our financial institutions, investment-grade ratings and our competitive public procurement processes are valued elements in the sustainability and integrity of our transformation path.”

While dropping any mention whatsoever of privatization, which had been suggested in the 2016 budget, a firm commitment to expenditure ceilings, budget deficit reduction and lower debt to GDP will likely be rewarded by the financial markets.

• The state budget should ensure that South Africa keeps its investment grade status averting any downgrade by the credit rating agencies to junk level.

• Pravin Gordhan’s statesman-like performance and his clear popularity and support during the budget speech, in stark contrast to the president’s State of the Nation Address, will make it increasingly difficult for President Zuma to sideline the finance minister.

For the full report, including a look at international markets, click here.

* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.

Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.

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