Budget 2022: Pragmatically cautious amid elevated uncertainty
Finance Minister Enoch Godongwana’s maiden budget speech was generally seen as cautious, with a focus on debt stabilisation and social protection. There is modest further upside to tax revenues and reasonable buffers built into the expenditure projections, making the FY23 budget achievable, albeit with numerous risks. While the headline numbers improved almost across the board, we believe the budget is market neutral given that a lot of optimism was already priced heading into the budget.
SARS banks an extra R182bn
Following the estimated tax revenue overrun of R120bn at the time of the Medium Term Budget Policy Statement (MTBSP) in November last year, the additional tax take is estimated at R62bn. This consists of R30bn additional corporate income tax receipts, R11bn from individuals and R10bn from VAT.
The post-lockdown rebound in the broader economy and surging commodity prices account for roughly a third of the R182bn aggregate revenue overrun, according to SARS Commissioner Kieswetter[1]. The bulk of the overrun can be attributed to improved collections by SARS, in particular in dealing with VAT claim fraud (R55bn) and collections of arrears (R47bn). This detail is encouraging, as it proves that the SARS rebuild is paying off relatively quickly, with further upside from broadening the tax base to make for more sustainable revenue growth.
Revenue windfall eases debt strain and funds social spending
The resultant cash build has been used to fund a large part of the FY21/22 financing requirement – R48bn of R412bn – with a further R100bn drawdown pencilled in for FY22/23. Excess revenues are also allocated to social welfare via a 12-month extension to the Special Relief of Distress Grant, which amounts to R44bn. Importantly, there is no SDR grant allocation beyond FY22/23, although the budget retains an unallocated reserve totalling R55bn over FY23/24 and FY24/25.
The budget does not allow for a basic income grant, as the Finance Minister rightly notes that a structural increase in spending would require a structural increase in revenues, i.e. a personal income tax or VAT rate hike. However, given socio-economic and political economy pressures, a basic income grant poses upside risk to expenditure in the medium term.
Other pro-poor and pro-consumer aspects include inflation-linked increases in the various grants following years of below inflation adjustments, a slight broadening of the welfare net, tax relief via the lack of fiscal drag and unchanged fuel and Road Accident Fund levies in light of record domestic fuel prices.
The budget attempts a tough stance on the wage bill, but in rolling over the cash gratuity and allowing for a 2.6% rise in the compensation line, Treasury acknowledges that wage negotiations will be tough when inflationary pressures – notably in food and transport – are mounting.
Godongwana followed through on Mboweni’s commitment to cut the corporate income tax rate by 1ppt, to 27%, although this is offset by other indirect corporate tax measures to make it revenue neutral. In addition, offshore limits for insurance, retirement, and savings funds are harmonised to 45% from 40% (both inclusive of the 10% African allowance).
Prudent assumptions, but risks abound
On balance, the macroeconomic assumptions underlying the revenue projections are prudent. That said, we do not think they are overly cautious in the hope for another upside surprise. As it stands, the budget increased the FY22/23 revenue projection by R75bn versus the baseline, suggesting some spillover of the positive revenue drivers into the next fiscal year.
The fiscal position will be sensitive to the commodity price cycle, as well as to the next round of public sector wage negotiations. There were no additional allocations made for State Owned Entities, yet there is still a substantial risk that guarantees are crystallised, which would increase the government’s explicit debt burden.
On balance, we think it was the correct strategy not to rely on multi-year commodity price revenue increases.
Debt stabilisation on the horizon
The Treasury’s debt projections are plausible, as the primary budget balance tips into positive territory in FY23/24. The debt ratio is expected to peak at 75.1% in FY24/25 and decline slowly thereafter. Based on our analysis, this profile is reliant on growth picking up sustainably towards 3.0% and/or the effective interest rate on debt falling further and/or ever rising primary surpluses (highly unlikely).
The bottom line is that South Africa has an “r – g” problem, i.e. the effective interest rate that the government pays on its debt exceeds the real growth rate in the economy, and has done so for many years.
Some optimism is on the cards with regard to narrowing this differential. Government is focusing on sourcing cheaper funding, particularly via International Financial Institutions such as the World Bank, the IMF, and the New Development Bank. In addition, a positive feedback loop between a better fiscal outlook and stabilising sovereign credit ratings could lower the risk premium embedded in government bond yields. Accelerated reforms would lift trend growth in the longer term.
Funding profile suggests more, not less bond supply
For bond investors the short-term key focus in the budget is what will happen to the weekly auction sizes. There is notable disagreement among analysts, as the detailed funding strategy seems quite vague. The budget notes the introduction of a domestic floating-rate note and Sukuk bond, but the budget does not give a timeline or indication of the size of these issuances.
The FY22/23 funding is reliant on a combination of cash and domestic long-term bond issuance. The latter will very likely be biased towards fixed-rate bonds rather than inflation-linked bonds. That said, we do not believe an increase in issuance is imminent given further revenue upside in the short term and ongoing switch auctions. If the Treasury is unable to source funds from the Eurodollar bond market or the floating-rate note is delayed, then we would expect an additional c.R1bn of fixed-rate bonds in the weekly auction.
Budget not an obvious game changer
For many years, fiscal risks were one of the primary factors keeping the SARB on the hawkish side. While the budget is credible, with improving deficit and debt metrics, the fundamental fiscal position is still fragile. However, the budget is good enough for government’s finances to move to the back burner in monetary policy deliberations. Rather, the SARB’s focus is on global monetary policy dynamics and inflation risks. On this score, the Fed’s 16 March FOMC meeting is the key event to watch ahead of the SARB’s interest rate decision on 24 March.
Sustained high commodity prices could lead to stronger revenue growth and beneficial spillovers to the broader economy. This would broaden the tax base and lead to earlier debt stabilisation at lower levels. However, we are not convinced that the channels are as readily available as they were in the 2000s commodity price boom. Business confidence and investment rates remain depressed, electricity capacity is still constrained, and banking sector regulation has dampened the credit cycle.
Granted,
these constraints will not negate the impact of the positive terms of trade
boom, but a more volatile global policy and growth backdrop may exacerbate
them. Substantial reform is required to lift South Africa’s longer-term growth
trajectory.
[1] RSG Geldsake met Moneyweb, 23 February 2022
