South African National Budget 2018/2019 – a brief review The South African Minister of Finance, Malusi Gigaba, delivered his first National Budget on Wednesday, 21 February 2018. This was one of the most widely anticipated National Budgets in recent years. In particular, ahead of the budget there was significant debate about possible tax changes, including the increase in the VAT rate, as well as the need for government to control key expenditure items such as salary payments, but also fund tertiary education and national health insurance. The demands on the Minister, however, extended well beyond issues relating purely to revenue and expenditure. These included the urgency for government to start to reform the management and financing of State Owned Enterprises (SOEs), the need to clarify key economic policies, the importance of lifting business confidence as well as avoiding any further credit rating downgrades. A daunting set of demands for any Minister of Finance. Although it is clear that government’s fiscal parameters have deteriorated substantially in recent years, leading to successive credit rating downgrades, the Minister was able to present a budget that is significantly better than the Medium Term Budget Policy Statement (MTBPS) issued in October 2017. Back in October 2017, the MTBPS reflected a shock deterioration in all of the government’s key fiscal parameters, especially revenue collection, and government debt. This dramatically increased the chances that South Africa’s credit rating could be cut to below investment grade by all of the rating agencies. Fortunately, the latest set of budget parameters, together with recent political developments, greatly reduces the chances of further credit downgrades in the short-term. Nevertheless, a significant amount of work still needs to be done to lift business and consumer confidence, encourage private sector investment and sustainably raise economic growth. Government’s latest growth projection of just over 2% in 2020 is hopelessly below the level South Africa requires to create employment, lift incomes meaningfully and reduce inequality. The 2018/2019 budget numbers For the 2018/19 fiscal year the Minister of Finance announced that the budget balance should improve to -3.6% of GDP, down from -4.3% of GDP in 2017/2018. This is slightly better than the deficit the Minister projected in the October 2017 Medium Term Budget Policy Statement (MTBPS). The fiscal deficit is then expected to remain unchanged in 2019/2020 as a percentage of GDP, before falling to -3.5% of GDP in 2020/21. It should be mentioned that in prior years the government had aimed to reduce the budget deficit to below -3% of GDP, but clearly the sustained lack of economic growth coupled with subdued revenue collection has thwarted those ambitions. The government also intends to achieve a primary budget surplus (which is the budget deficit less interest costs) of 0.1% of GDP in the current fiscal year. This would be a very welcome achievement, after recording a primary budget deficit of -0.7% of GDP in the past fiscal year, and will go a long way towards convincing the public, investors and credit rating agencies that government is serious about its intention to achieve a more disciplined financial framework. Unfortunately, while the projected reduction in the budget deficit and improvement in the primary balance over the next three years reflects an intention to adhere to fiscal discipline, South Africa’s National Treasury has developed a reputation in recent years for not being able to achieve the targets articulated in the budget. Consequently, the emphasis within government’s economic policy will now have to focus very heavily on raising economic growth on a sustainable basis. Without an acceleration in economic activity, the fiscal authorities will once-again struggle to improve tax collection and meet their budget objectives. It is also clear that given the current balance sheet constraints within central government as well as SOE sector, economic policy will have to increasingly promote the role of the private sector in driving economic growth. We would hope this includes a greater reliance on Private-public partnerships. The revenue side of the budget In 2017/2018 tax revenue massively underperformed budget by an estimate R48.2 billion. While this is largely in-line with the revenue shortfall the minister highlighted in the October 2017 MTBPS, it represents a huge miscalculation by National Treasury and meant that government had to borrow substantially more than it had anticipated at the start of the fiscal year. A breakdown of this revenue shortfall shows that the under-collection has been very broad-based and includes a dramatic R21 billion shortfall in individual tax collection, a R14 billion under-collection of VAT and a R3.6 billion lapse in the collection of customs duties. In contrast, company tax collection was in-line with budget, while the fuel levy exceeded budget. Unfortunately, the latest revenue shortfall means that government has missed their revenue targets for four consecutive years, forcing the authorities to look for additional sources of funding. Back in the 2017/2018 budget the emphasis was on increasing in the top marginal tax rate for individuals from 41% to 45%, whereas in the latest budget the decision was taken to increase the VAT rate from 14% to 15%. The authorities hope that by increasing VAT by 1 percentage points they can raise an addition R22.9 billion. This certainly seems ambitious in an economy that is projected to grow by a mere 1.5%.
Transcript
South African National Budget 2018/2019 – a brief review
The South African Minister of Finance, Malusi Gigaba, delivered his first National Budget on Wednesday, 21 February 2018. This was
one of the most widely anticipated National Budgets in recent years. In particular, ahead of the budget there was significant debate
about possible tax changes, including the increase in the VAT rate, as well as the need for government to control key expenditure
items such as salary payments, but also fund tertiary education and national health insurance. The demands on the Minister, however,
extended well beyond issues relating purely to revenue and expenditure. These included the urgency for government to start to reform
the management and financing of State Owned Enterprises (SOEs), the need to clarify key economic policies, the importance of lifting
business confidence as well as avoiding any further credit rating downgrades. A daunting set of demands for any Minister of Finance.
Although it is clear that government’s fiscal parameters have deteriorated substantially in recent years, leading to successive credit
rating downgrades, the Minister was able to present a budget that is significantly better than the Medium Term Budget Policy
Statement (MTBPS) issued in October 2017. Back in October 2017, the MTBPS reflected a shock deterioration in all of the
government’s key fiscal parameters, especially revenue collection, and government debt. This dramatically increased the chances that
South Africa’s credit rating could be cut to below investment grade by all of the rating agencies.
Fortunately, the latest set of budget parameters, together with recent political developments, greatly reduces the chances of further
credit downgrades in the short-term. Nevertheless, a significant amount of work still needs to be done to lift business and consumer
confidence, encourage private sector investment and sustainably raise economic growth. Government’s latest growth projection of just
over 2% in 2020 is hopelessly below the level South Africa requires to create employment, lift incomes meaningfully and reduce
inequality.
The 2018/2019 budget numbers
For the 2018/19 fiscal year the Minister of Finance announced that the budget balance should improve to -3.6% of GDP, down from
-4.3% of GDP in 2017/2018. This is slightly better than the deficit the Minister projected in the October 2017 Medium Term Budget
Policy Statement (MTBPS). The fiscal deficit is then expected to remain unchanged in 2019/2020 as a percentage of GDP, before
falling to -3.5% of GDP in 2020/21. It should be mentioned that in prior years the government had aimed to reduce the budget deficit to
below -3% of GDP, but clearly the sustained lack of economic growth coupled with subdued revenue collection has thwarted those
ambitions.
The government also intends to achieve a primary budget surplus (which is the budget deficit less interest costs) of 0.1% of GDP in
the current fiscal year. This would be a very welcome achievement, after recording a primary budget deficit of -0.7% of GDP in the
past fiscal year, and will go a long way towards convincing the public, investors and credit rating agencies that government is serious
about its intention to achieve a more disciplined financial framework.
Unfortunately, while the projected reduction in the budget deficit and improvement in the primary balance over the next three years
reflects an intention to adhere to fiscal discipline, South Africa’s National Treasury has developed a reputation in recent years for not
being able to achieve the targets articulated in the budget. Consequently, the emphasis within government’s economic policy will now
have to focus very heavily on raising economic growth on a sustainable basis. Without an acceleration in economic activity, the fiscal
authorities will once-again struggle to improve tax collection and meet their budget objectives. It is also clear that given the current
balance sheet constraints within central government as well as SOE sector, economic policy will have to increasingly promote the role
of the private sector in driving economic growth. We would hope this includes a greater reliance on Private-public partnerships.
The revenue side of the budget
In 2017/2018 tax revenue massively underperformed budget by an estimate R48.2 billion. While this is largely in-line with the revenue
shortfall the minister highlighted in the October 2017 MTBPS, it represents a huge miscalculation by National Treasury and meant that
government had to borrow substantially more than it had anticipated at the start of the fiscal year.
A breakdown of this revenue shortfall shows that the under-collection has been very broad-based and includes a dramatic R21 billion
shortfall in individual tax collection, a R14 billion under-collection of VAT and a R3.6 billion lapse in the collection of customs duties. In
contrast, company tax collection was in-line with budget, while the fuel levy exceeded budget.
Unfortunately, the latest revenue shortfall means that government has missed their revenue targets for four consecutive years, forcing
the authorities to look for additional sources of funding. Back in the 2017/2018 budget the emphasis was on increasing in the top
marginal tax rate for individuals from 41% to 45%, whereas in the latest budget the decision was taken to increase the VAT rate from
14% to 15%. The authorities hope that by increasing VAT by 1 percentage points they can raise an addition R22.9 billion. This
certainly seems ambitious in an economy that is projected to grow by a mere 1.5%.
Other significant tax changes announced in the budget included a sizeable increase in the fuel levy as well as the road accident fund,
a below inflation adjustment to the tax thresholds for individual taxes, an increase in estate duty, a hike in the normal range of excise
duties, a moderation in the medical aid tax credits and the inclusion of a range of taxes relating to the environment and health.
Government estimates that the increase in VAT together with the other tax changes we highlighted, will yield an additional R36 billion
in tax review.
Overall, the decision by government to raise the VAT rate was clearly not easy, especially considering the social and political risks
associated with an increase in any regressive tax under conditions of high unemployment. Nevertheless, the decision seems
appropriate given the need to broaden the revenue base and not simply rely on further increases in the top marginal tax rate.
Ultimately, though, the tough decision government has had to make on raising taxes in recent years reflects the consequences of a
lack of job creation.
The expenditure side of the budget
In 2018/2019 government expects to spend a total of R1.67 trillion, which is 7.3% more than it spent in 2017/2018. This ismodestly higher than the projected inflation rate of 5.3%, allowing government to largely adhere to its expenditure ceilingImportantly, spending on staff and salaries, which consumes 35% of all expenditure, is projected to grow at an average of 7.3%per annum over the next 3 years, highlighting government’s commitment to containing the rate of increase in consumptionspending. A key area of growth in government spending during 2018/2019 is education, especially post-school education and training. In total
government has allocated an additional R57 billion of new spending fee-free higher education and training over the next 3 years. This
reflects government earlier promises to help students that are currently struggling to afford higher education, especially tertiary
education.
There is also a sizeable increase in social spending, with the number of social grants recipients projected to rise to over 18 million in
2020. To some extent, the latest increase in spending on social grants reflects an attempt by government to offset the negative impact
of a higher VAT rate on poorer households. While this initiative is to be applauded, it also raises the base of social spending in South
Africa which will become increasingly problematic without an immediate and sustained rise in employment.
The government’s healthcare budget will also see a sizeable increase in expenditure over the next three year. Government has
indicated that they are continuing to implement National Health Insurance (NHI) and decided to support this initiative by reducing the
tax credits to medical scheme as a means of increasing the funding the future expansion of the NHI.
Lastly, and unfortunately, there is still not enough in the budget to directly promote job creation. South Africa’s unemployment rate
remains far too high by historical and international standards, and clearly contributes much of the social tension and anguish
experienced in South Africa on a daily basis. Increasing employment in South Africa has to be the number one
economic/political/social objective.
Debt servicing costs continue to rise at a very rapid pace
While South Africa’s public sector debt parameters are now projected to improve relative to the disastrous projection outlined in the
MTBPS, the total debt as well as the cost of servicing that debt is clearly on the rise. For example, back in 2009, government’s gross
debt totaled only 26% of GDP and is projected at 53% in 2018/2019. If left unchecked, government debt will quickly become a major
hindrance to achieving many vital policy objectives.
In addition, a key risk to South Africa’s ongoing fiscal stability is the increase in state debt cost. While the interest cost on state debt
remains manageable at just below 12% of total expenditure, it is now consistently the fastest growing component of government
expenditure. In fact, nominal growth in interest and rent on land is expected to average well over 10 per cent over the next three years.
Under these circumstances, a significant rise in bond yields, due to further credit rating downgrades, would put South Africa’s fiscal
position under increasing strain. Already the cost of debt exceeds the total budget allocation to public order and safety and is one of
the fastest rising components of state spending.
Conclusion
The 2018 National Budget was presented in an environment of intense scrutiny and high expectations. The dramatic revenue under-
collection and weak economic growth meant National Treasury had to make tough decisions. Either it had to decide to allow the
budget deficit to increase significantly further in 2018/2019 and thereby risk an almost certain ratings downgrade to below investment
grade by Moodys in March 2018, or it had to decide to do the unpopular thing and raise the VAT rate. Treasury obviously chose the
tax hike option, which has allowed them to reflect a clear intention to restore fiscal discipline, giving South Africa a better than 50%
chance of maintaining its investment credit rating by Moodys.
However, and very importantly, the trade-off for this policy choice is that the recent tax hikes (VAT and others) will undoubtedly hurt
the weak economic environment, potentially depressing the already subdued rate of economic expansion in key sectors of the
economy.
This means that government needs to urgently focus on removing the key factors constraining economic growth. These factors include
policy uncertainty, high levels of corruption in both the private and public sectors, poorly performing SOEs, a lack of fiscal discipline
and low levels of business confidence.
Some of these constraints might be relatively easy to resolve, such as scrapping the proposed mining charter, while others would
require a larger degree of policy innovation such as the extensive use of private-public partnerships – fortunately the use of private-
public partnerships, as well as the sale of non-strategic state assets, were highlighted as policy options in the budget. Clearly, some of
the constraints outlined above will prove more difficult to resolve than others, but as the long as government demonstrates a firm and
ongoing commitment to lifting economic growth while at the same time maintaining fiscal discipline, business confidence and
