Mid-term budget speech commentary from Nicky Weimar

By Nedgroup Investments

Nicky Weimar, Chief economist at Nedbank provides an overview of the mid-term budget speech and highlights the key take-outs.

To watch a recording of the webinar go to YouTube.

South Africa is at cross-roads, with a drastically slowed and slowing economy and a huge debt burden. There is no doubt that in any budget upcoming, some tough decisions need to be made. Therefore, most South Africans were watching with great interest to the mid-term budget speech delivered by Tito Mboweni.

In June, via the supplementary budget, Tito Mboweni warned us that we were looking at government revenue going down and government expenditure rising rapidly – partly due to the health emergencies of COVID-19 and partly due to the effects of lockdown, which in South Africa were severe. Therefore, this budget was delivered against the backdrop of a huge gap between expenditure and revenue.

While the mini-budget doesn’t (and cannot) seek to change that, the goal is to try to reduce the gap and to ultimately close it by 2023. This deadline has now been moved to 2014. This extension of deadlines is an old trick by the South African government and we have seen this happen many ties before.

There is nothing very expansionary about this budget. It is really about the implosion of revenue that makes the deficit so bad. It is the implosion in tax revenue that contributes in such a dramatic way to the rise in public debt burden. Furthermore, the spending itself is also not stimulatory – it is really just supportive to keep the economy functioning but it is not helping South Africa grow faster.

The consolidated framework of this budget is a far more accurate view on what is actually happening because it includes provincial government and local authorities. This view shows the budget deficit widening to -15.7% of GDP and then only closing very slowly, staying well over the 3% level for as far as the projection shows. We don’t even get sight of the 3% level in this view.

The 3% level is an important indicator because numerous empirical studies have shown that if a country runs a budget deficit of over 3% for an extended period of time, essentially the borrowing on an annual basis that, with the cumulative effect of interest, the debt accumulates far too rapidly for it to be viable. If a country does run a deficit of over 3%, ideally the majority of that debt should be used for expansionary efforts. However, the debt level that South Africa is at now is simply dangerous and this is illustrated by looking at the projected debt in the recent budget.

The bigger question is: How did we get here?

South Africa was in an economic mine before COVID-19. We were in the middle of our longest economic downswing since records began in 1945. South Africa entered a downturn in December 2013 and we have stayed there. The pandemic has only made this worse.

The bulk of the damage was done in April. From May, a recovery did start (albeit coming off an extremely low base) but unfortunately most of the damage was already done. This is what has resulted in revenue falling from 29% of GDP to only 26.3%. This is substantially worse than the revenue to GDP ratio of South Africa in the global financial crisis - and it is this implosion in revenue coupled with the increase in expenditure that has brought is to the situation we are in.

What are the assumptions that this framework is based on?

The first thing this budget indicates is that government will very likely have to revise their growth estimate for this year.

The first half of the year GDP figures tend to set the tone for the rest of the year. Nedbank’s forecast anticipates a contraction in GDP of -9.2% while Treasury is expecting a contraction of -7.8%. We are taking into consideration a couple of structural issues that we think will re-emerge – such as power outages and a very dated electricity system– that will make it very difficult for South Africa’s recovery to gain momentum. The other thing that we are factoring into our forecast is that we don’t think COVID-19 is out of the way. That is very clear from recent developments – Germany and France have both decided to re-enter national lockdown just a few days ago.

That means that for those two countries there will be another implosion of economic recovery in the final quarter of this year, and as a result, the global economy is looking very vulnerable. The USA has also reported the highest infection rates since the pandemic began so they could also look at further restrictions in the near future. More importantly, South Africa has not seen the return of international tourists and unfortunately it doesn’t look like we will any time soon. This will likely affect the economic indicators in the final quarter of this year and we have taken this into consideration.

We also have a weaker recovery projection when compared to National Treasury. We still believe Covid-19 is still going to be an issue even if there is a vaccine because apparently the virus is now mutating. With all these issues at play, there is still so much uncertainty which is all built into our outlook for 2021.

With these sorts of growth numbers, the South African economy will likely only get back to 2019 levels by 2024.

The recent budget also shows that income tax collections have dropped significantly this year, although VAT numbers have bounced back nicely which indicates that the spending is picking up. The issue is that corporate taxes and personal taxes are not picking up and, as a result, government revenue is going to be under strain.

National Treasury has therefore made it clear that there will be increase in tax. The exact structure for these increases is not yet clear but will likely be sugar tax and excise duty on luxury goods over the next three years, to name a few. Increasing VAT is usually the most effective option, but it is highly politicised in South Africa and therefore it’s likely that government will look to other ways of increasing tax before increasing VAT. This in turn means we can expect to see the tax system become more complex in an effort to avoid raising the VAT rate.

On the expenditure side, as a result of the budget deficit we are rapidly entering an unsustainable situation and debt servicing costs remain the fasted growing expenditure item on the budget - consuming 21 cents of every rand of revenue. It is likely to remain this way for the next 3 years.

There are efforts to direct expenditure towards infrastructure projects. However, it is very unclear where the financing for this will come from and how many of the projects are realistically going to get off the ground. Furthermore, securing the private sector funding to finance these projects is very unlikely at the moment. If we are going to see a recovery, we will first need to see a rise in demand which we anticipate only coming through in 2022 for South Africa.
 
Education is currently the biggest expenditure item in the budget and there are some cuts planned in this sector – but this is likely it to be in the form of eliminating inefficiencies that already exist. Encouragingly, large cuts are also planned for the public sector, and the public sector wage bill with wage constraints for the next three years.

The bigger picture shows that because the debt servicing costs cannot be controlled, the only measures available to government are to chip away at the debt burden.  South Africa has the biggest increasing debt burden of all the emerging market countries. This is what makes it a huge challenge and definitely the biggest problem for the government to tackle over the coming years.

Government cannot stimulate the economy. The only thing government can do is create an enabling environment which means structural reforms can no longer be. The reconstruction and recovery plan has good elements, but it is very thin on addressing the uncertainties that are keeping foreigners away from investing in South Africa. Laws around private property ownership and mining regulation are a few of the biggest stumbling blocks here.

It is, sadly a messy picture – and will stay that way for some time. We only hope the forecasts do not continue to be adjusted for the worse and that we start to see some certainty and a clearer way forward.