Read our pre-budget commentary, Short-term fiscal reprieve leading to longer-term benefit?
Historically, the tabling of the February budget has presented a rosier picture than the previous year’s mid-term budget speech in October. This year was no different as National Treasury reiterated its commitment to consolidation in the context of a fast deteriorating fiscal position which was further decimated by the COVID-19 pandemic. The well-telegraphed revenue overrun was certainly the star of the show, coupled with holding the line on expenditure cuts. We continue to explore if this short-term reprieve will contribute to resuscitating the ailing fiscus.
Robust revenue collection is expected to continue
National Treasury delivered on the anticipated revenue overrun of nearly R100 billion, the first time since the global financial crisis that we have seen an overrun of this magnitude. When looking at the medium term (fiscal years 2021/22 to 2023/24) National Treasury has also pencilled in significant increases in revenue collection amounting to R113.9 billion. Given this bullish revenue outlook, we remain cautious about the long-term trajectory of revenue collection due to several factors.
But anticipated revenue growth may be overly optimistic
Upon further analysis, we believe that government’s revenue expectations in the outer years of the medium-term are quite ambitious. The R113.9 billion expected increase is not supported, with some indications that revenue growth is likely to be less robust. To name a few:
- Low real gross domestic product (GDP) growth: Treasury’s estimates remain on the conservative side, with a projected recovery of 2.2% and 1.6% in 2022 and 2023, respectively. While these more conservative forecasts lend the budget some creditability, the strong positive relationship between economic growth and revenue collection, and a continuation of the low growth environment coupled with a benign inflation outlook, suggests that revenue collection is likely to remain under pressure;
- Lack of additional tax measures: previous budgets pencilled in additional revenue of R40 billion from various tax measures, but a large portion of these tax hikes did not come through in the 2021 budget. While this is welcome news from a tax payer’s perspective, it does point to a stressed tax base; and
- High tax buoyancy assumptions (tax buoyancy explains the relationship between revenue collections and economic growth): Treasury’s further reduction in tax buoyancy closer to levels reflective of the stressed tax base is worth noting however, the estimates are still quite high. This is illustrated in Graph 1 below, which compares budgeted buoyancy to previous years’ levels.
On a positive note, it would be remiss on our part to exclude the potential efficiency gains at the South African Revenue Services (SARS), and the resultant impact that these will have on revenue collection. National Treasury announced a further allocation to SARS of R3 billion, which should contribute to its specialised audit and investigative functions. We certainly applaud this, but given that it took five years to decimate this institution in the so-called Zuma years, it is our view that it will take a similar timeframe to rebuild it to its full capability. This should bode well for revenue beyond the medium-term period.
On balance, while the latest budget was significant in terms of exceeding the forecasted revenue collection in the October 2020 Medium Term Budget Policy Statement (MTBPS), there was still a big reduction in revenue of R213.2 billion compared to the initial 2020 budget estimates. This clearly illustrates the impact the COVID-19 induced lockdown had on economic activity and revenue collection and is indicative of the very vulnerable fiscal position.
Graph 1: Tax buoyancy levels still quite high relative to history
Source: National Treasury, Futuregrowth
While the intention to hold the fiscal line is applauded, execution risk and expenditure pressures remain
In a further demonstration of its commitment to fiscal consolidation, National Treasury revised expenditure lower by a cumulative R34 billion until the 2023/24 fiscal year. The total baseline reduction over the medium-term is R265 billion (4.6% of GDP). These expenditure reductions include cutting out inessential government-funded programmes. This is positive in our view and continues the recent trend in prior budgets to focus on cutting superfluous expenditure as opposed to raising revenue. The fact that real non-interest expenditure is expected to grow by 0.4% over the medium term, together with the shift away from current expenditure (i.e. cutting wage expenditure and government-funded programmes), indicates that National Treasury remains resolute about holding the fiscal line – which we applaud.
Public sector wage reductions are debatable
Conversely, we remain concerned about the execution risk related to the magnitude of the proposed cuts to expenditure, largely because a significant portion of the reduction comes from the public sector wage bill. The public worker compensation budget is now projected to grow 2.1% this year and 1.2% per annum over the medium term, representing a pay freeze and some headcount reduction from early retirement and natural attrition. Our previous analysis, which was based on our assessment of historical wage negotiations between the government and trade unions, suggested that a more realistic scenario would have been inflation-linked increases. This is particularly the case for the low-to-medium grade salary brackets, which make up 80% of government personnel. It is positive for the fiscus that unions have been unable to strong-arm government into acceding to unrealistic and unaffordable wage demands, or to enforce the wage agreement for 2020/21 via the courts. However, the ongoing impasse between Treasury and trade unions regarding the 2020/21 wage freeze and the fact that negotiations for the upcoming wage agreement are still in progress, suggest that the implementation risk on the proposed R144 billion reduction remains a notable concern.
SOE risks persist
The budget was also relatively light on details on future bailouts of State Owned Enterprises (SOEs) and government guarantees. Land Bank is the only SOE that has been allocated funding over the medium-term, and is expected to receive R7 billion in bailouts (R5 billion in FY21/22 and R1 billion over each subsequent year). Although additional bailouts have not been pencilled in, Denel, Eskom and SAA currently remain reliant on state support. Therefore, poor SOE management remains a risk that will pose upward pressure on expenditure. Incorporating sovereign debt and contingent liabilities into the net loan figure (see Graph 2) highlights the significant risk that the precarious financial positions of SOEs add to the national debt ratio. The crystallisation of contingent liabilities remains one of the risks we are closely monitoring.
Graph 2: Poor SOE management holds a significant risk to the debt ratio
Source: National Treasury, Futuregrowth
Slight improvement in debt metrics lead to a reduction in issuance
Better than expected revenue collection and contained expenditure have resulted in the consolidated budget deficit being revised lower to 14% of GDP from 15.7% of GDP for 2020/21, and expected to narrow to 6.3% of GDP by 2023/24. However, we still do not see a stabilisation of the debt burden over the medium term, with Treasury forecasting it to reach 87.3% of GDP by 2023/24. Moreover, the gross debt-to-GDP ratio is now expected to peak at 88.9% in the 2025/26 financial year, down from the 93.5% tabled in the MTBPS. The borrowing requirement over the medium term has decreased significantly, with the outer years showing strong compression (see Table 1 below). Positively, we are likely to see a reduction in the weekly nominal and ILB auction issuance.
Table 1: Borrowing Requirement (R’bn)
Source: National Treasury, Futuregrowth
Our analysis before the February budget pointed to a lower debt burden relative to the October 2020 MTBPS. Thus we are loath to see the latest budget as a positive inflection point, given the continued steep upward trajectory of the debt profile and the elevated average funding cost. Additionally, in the absence of real GDP growth above 2.5%, we see the debt burden remaining a pressure point.
South Africa’s Fiscal Strength Score
With the aim of taking a holistic view of the wealth of data and information available on South Africa’s fiscal position, we have built a matrix consisting of several public sector and relevant macroeconomic indicators. These metrics are scored individually, based on historical data points as well as estimates for the medium term. The result is our Fiscal Strength Score, illustrated in Graph 3 below. This clearly shows the deteriorating trend that started around the global financial crisis and has progressively worsened since, having now reached the worst level for the period starting in 1996. While we do anticipate a slight improvement in the score at the end of the medium term, the score is set to remain in the doldrums for some time.
Graph 3: South African Fiscal Strength Score (1997–2024) remains at the lowest level since 1996
Source: National Treasury, Bloomberg, Futuregrowth
// KEY TAKEAWAYS
- We remain concerned about the more positive revenue outlook - particularly in the outer years - given that it is not accompanied by higher real GDP growth, improved tax buoyancy or any additional tax measures.
- The longer-term picture remains uncertain, hinging on large expenditure cuts (particularly to the public sector wage bill) and strong, sustainable growth – both of which have not been experienced in SA since before the global financial crisis.
- Although the debt ratio is set to peak at a lower level of 88.9% of GDP, it is still incredibly high and unsustainable given our and National Treasury’s growth outlook, as well as elevated average funding cost.
- A holistic view of the fiscal position still suggests a precarious situation regardless of a “better” budget.
Prospect of resuscitation unlikely
Unfortunately, without serious structural reform, coupled with a sustainable higher growth path, the recent relatively positive budget merely sets South Africa’s fiscal position on a slower path to further deterioration – not the much-needed path to recovery.