I have attended the budget lock-up for economists and analysts since it started in 2013. I always look around the lock-up room at the faces of the other analysts to gauge the first reaction to the budget and general sentiment. In recent years, I have become accustomed to the shaking heads and wide eyes. Yesterday was different. Initially the budget was a little perplexing. Was this it? Was this the strategy we have been waiting and hoping for? However, in reading the budget document in its entirety I left the budget lock-up feeling optimistic for the first time in a long while.
To say I “love” this budget is probably a bit too strong – how can you love something that tells you how much you can spend and on what you have to spend it. But I really like this budget. Not because it is market-friendly – which it is. Nor because it will please the rating agencies – which it should. But because this could very well be the turning point for the fiscal strategy.
I disagree with the view that the budget was solely “made for Moody’s” and do not believe that the budget is a negotiating tool. Rather, I think it is a potential fundamental shift to address South Africa’s fiscal constraints. Even so, the budget must, as always, deliver for a wide-ranging audience, from politicians and consumers (the potential voters), to trade unions and businesses, and to rating agencies and investors. In this light, we can critique the budget on a few measures. Importantly, is it growth-friendly? Yes, as much as it could possibly be under the current circumstances. Is it credible? Yes, the details are achievable, but, as always, execution risk is large. Is it in line with debt sustainability? No, not in the medium term, which the budget explicitly acknowledged, but it could be in the longer run. Based on reasonable assumptions debt could stabilise at 78% of GDP in ten years’ time.
Consolidation remains incremental and the debt-to-GDP ratio will continue to rise, but the nuances in the budget indicate that finance Minister Mboweni and his team at National Treasury finally “get it”. Maybe they “got it” all along, but they finally have the courage to adopt riskier but fundamental strategies that could start turning the fiscal position towards sustainability.
Following significant adjustments since 2015, they have realised that further tax increases will be growth destructive given the elevated tax-to-GDP ratio of 26% and the narrowing tax base. This budget even gives modest tax relief to individuals. Hence, the budget proposals can be deemed “growth-friendly austerity”, even if this is generally seen as an oxymoron. Granted, there will be a growth offset from the proposed spending cuts, but in not raising taxes further, this budget could stem the ongoing deterioration in confidence.
The medium-term budget strategy is twofold: broaden the tax base and lower spending on wages.
The former will in part be achieved by reducing so-called tax expenditures – these are tax revenues foregone due to exemptions. In FY18, corporate income tax expenditure totalled R12bn, VAT exemptions were R56bn, and customs duties and excise were R34bn. Hence, there is significant scope to enhance revenues via sunset clauses and reviewing current tax breaks.
The tougher task will be to lower the wage bill, particularly in the first year as this is still under the 2018 wage settlement. The potential saving is R160bn in aggregate, which is almost 3% of GDP. National Treasury is frank in how big this challenge is, but emphasises that the longer it takes to start the curtailment, the more costly it will become.
The “it” that National Treasury effectively acknowledges is the fact that our structural spending is too high relative to our structural economic and revenue growth and that the composition of spending is not productivity enhancing. The government needs to implement policies that will lower structural spending, increase structural growth, create space for other structural spending – notably the NHI – and that will make the country globally competitive.
How does this budget move government towards achieving these overarching goals?
Firstly, the proposed wage bill cuts will not only reduce the aggregate level of consumption structural spending, but will also help to shift the composition in spending away from consumption and towards fixed investment. Secondly, government aims to implement reforms and further beef up institutions, such as SARS, to enhance growth and revenue collection. Thirdly, the budget seems to be laying the groundwork for a potential corporate income tax cut down the line, which will make us more competitive.
The market reaction yesterday afternoon indicates that investors like the budget almost as much as I do. Moreover, the budget lowers the probability of a rating downgrade by Moody’s in March, and increases the probability that the SARB will cut the repo rate as early as March. Equities embraced the absence of additional tax hikes, even if there will be some trade-off with lower wage growth for government employees. Bonds liked the fact that growth will not be hit by additional tax hikes, that issuance need not necessarily increase further, and that Moody’s will probably delay the downgrade to November. Both bonds and SA Inc stand to benefit from possible earlier and cumulatively larger monetary policy easing. Even the rand had a minor rally, but the bigger issue for the exchange rate is what is happening globally, hence the renewed weakness.
Whether the financial market gains are sustainable will partly depend on the negotiations between government and the unions to curtail the growth in the wage bill. It will be tough. National Treasury has opened the negotiation with wage increases limited to inflation, wage freezes for the high-earners, seemingly limited job cuts, and pending legislation to align excessive SOE pay to government employee compensation. Moreover, I would not be surprised if Treasury were to keep a VAT hike in its back pocket as a negotiating tool. Unions do not like job cuts or VAT hikes.
Based on media reports and interviews, Cosatu is ready to “declare war” with strike action and shutdowns following what they deem was an “underwhelming” budget. They have clearly accepted the challenge of this make-or-break wage negotiation.
I’m in Tito’s corner. Game on!