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Johannesburg - The improvements in the budget deficit and debt trajectories (from with the Medium-Term Budget Policy Statement (MTBPS) forecasts) exceeded our expectations.
These improvements were owing to a combination of substantial tax hikes (including a one percentage point VAT rate hike), more supportive macroeconomic assumptions (now incorporating higher growth and tax buoyancy trajectories), and large expenditure cuts (unfortunately including even bigger cuts to infrastructure spending than we expected).
Government’s cost estimates for the free tertiary education (FTE) policy were also below ours (with similar FTE assumptions, our budget deficit forecasts would have been similar to government’s forecasts by FY20/21). Tax hikes were somewhat bigger than expected, while spending cuts significantly exceeded our expectations.
Despite the increased optimism already apparent in recent weeks, we expect the bond and currency markets to react positively to the budget. There is relief to the bond market from the decline in the borrowing requirement, while the currency market may react slightly positively to a further decline in the likelihood of a sovereign credit rating downgrade by Moody’s to sub-investment grade.
The immediate impact of the significant fiscal consolidation on the equity market is negative (particularly for consumer and construction stocks), although there is still some comfort from the decline in the longer-term fiscal risks.
For credit rating agencies, the key is that the debt trajectory is now projected to stabilise by 2022 at 56.2% of GDP. While there are still some challenges and risks ahead, this supports our expectation that Moody’s will not downgrade SA at the end of the current rating review.
A reasonable balance
Overall, the budget struck a reasonable balance between fiscal sustainability and economic growth considerations, in our view.
The main budget deficit is projected to narrow from 4.6% of GDP in FY17/18 to 3.8% in FY18/19 (previously projected at 4.5% in the MTBPS) and 3.7% in FY20/21. The gross borrowing requirement retreats from R246bn in FY17/18 to R224.2bn in FY18/19 (with domestic short-term loans declining materially and domestic long-term loans retreating marginally).
The VAT rate increase should have a modest adverse impact on our inflation and consumer spending (and in turn economic growth) forecasts, but the impact should be transitory. We will shortly unpack these impacts, alongside the consequences for the interest rate trajectory, in a more comprehensive analysis of the budget.
The new revenue forecasts appear reasonable, though subject to moderate downside risk, in our view. While they are supported by higher (though not unrealistic) economic growth forecasts, the new (higher) tax buoyancy assumptions (while defendable) exceed ours and pose a moderate downside risk to the revenue projections.
The corrective fiscal steps taken in this budget exceeded our expectations, but they were augmented by what appears to be a shift in approach from erring on the side of caution in the underlying assumptions in the MTBPS towards a more optimistic bias in the budget.
In a nutshell, the key fiscal adjustments are tax hikes worth R36bn in FY18/19 (which feed through to the outer forecast years; this includes R22.9bn from a VAT rate hike) and R85bn of spending cuts (including R39.7bn cuts to capital transfers) over the medium term, which is counteracted by an additional R57bn allocated to FTE.
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