Public Finances on a more sustainable path

2018-10-28 17:45

In his maiden medium-term budget policy statement (MTBPS) speech, new Finance Minister Tito Mboweni correctly diagnosed South Africa’s macroeconomic and fiscal framework as being “at a crossroads”.

The crossroads have been visible for some time but have certainly appeared closer with South Africa’s debt burden having grown significantly in recent budget cycles. In this context, difficult trade-offs were required to lay down a credible path towards fiscal consolidation over the medium term.

The relatively muted response of the currency markets in the immediate aftermath of the speech suggests that the long road towards placing South Africa’s public finances on a sustainable path has indeed been laid out.

Why, despite the increase in the MTBPS period in the budget deficit and debt-to-GDP ratio, is this the case?

To begin with, the emphasis on growth-enhancing reforms and on clear and consistent policies was significant, given relative stasis in recent years. Prominent among these reforms was the minister’s frank admission of the weakened capacity of the SA Revenue Service (Sars) and his consequent allocation of R1.4 billion over the medium term towards reform – including regularising VAT refunds and strengthening the institution’s enforcement capacity.

Business has, in recent years, been concerned about apparent loss of capacity at Sars, reflected in the undercollection of revenue and the slow rate of payments of refunds.
Olivier Serrao, Business Unity SA economist

This announcement, therefore, signals a welcome statement of intent.

Government’s stated objective to partner with the private sector in infrastructure project financing, planning and implementation is a further signal of an emerging recognition of the pivotal role of private sector investment and involvement in realising and giving practical effect to government policy.

Similarly, the minister’s unequivocal support for the independence of the central bank, its mandate and the constitutional underpinnings upon which this rests, is a clear positive and reflects an orientation towards greater emphasis on macroeconomic stability.

Another positive, from a business perspective, is the commitment to maintain the expenditure ceiling announced in February, despite the 2018 public sector wage agreement exceeding budgeted baselines by R30.2 billion.

Crucially, the announcement that no further tax increases are proposed or envisaged at this time is a signal that government acknowledges – as contended by business – that further tax increases in the current environment are likely to stifle the economy and to ultimately prove self-defeating.

Only through growing the economy and expanding the number of corporate and individual taxpayers is sustainable revenue collection possible.

In short, many – if not all – of the right signals were made to demonstrate government’s intent to stabilise the public finances over time.

Importantly, this was done through avoiding outright austerity: real (above inflation) increases in social spending (education, health and social protection) over the medium term are retained.

The expansion of VAT zero-rating to include sanitary pads, bread flour and cake flour (at a cost to the fiscus of R1.2 billion) similarly seeks to shield the most vulnerable from the effects of increased taxation and economic marginalisation.

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At the same time, there is no avoidance of the fact that fiscal slippage has occurred.

Notwithstanding the positive signals to the market and investors emanating from the MTBPS, business is concerned about the projected increase in the budget deficit to 4.2% in 2019/20 and 2020/21, arising from an increased borrowing requirement necessitated by declining revenue forecasts.

The forecast increase in the debt-to-GDP ratio to 59.6% by 2023/24 is likely to yield increasing scrutiny of the sustainability of our public finances by rating agencies.

Debt-servicing costs remain the fastest growing item of expenditure, crowding out spending on social programmes and investment elsewhere in the economy.

By 2021/22, an estimated 15.1% of main budget revenue will be used to service debt, compared with 13.9% in 2018/19.

The downward revision in revenue growth projections complicates the matter in that much of the shortfall reflects increased VAT refunds to address backlogs at Sars and underestimation of refunds due.

Ironically, despite the negative impact on the budget in the near term, the relief gained by many businesses – particularly small, medium and micro enterprises – from clearing the backlog and the timely payment of refunds going forward will benefit the economy over the longer term.

While expenditure towards social spending has been maintained, and even increased in real terms over the MTBPS period, there will be real reductions (or minimal real growth, depending on inflation) in allocations to key functions such as agriculture and rural development.

In the context of widespread consensus on the need for swifter, more effective land reform and greater support for emerging farmers, this may prove potentially problematic.

The continued underperformance of state-owned enterprises (SOEs) remains arguably the biggest risk to the sustainability of the country’s finances.

The reconfiguration envisaged by Mboweni indeed requires a hard look at how they operate.

The net losses sustained by a number of SOEs in recent years, together with governance failings (reflected in a number of SOEs failing to release annual reports, as required by the Public Finance Management Act), point to deep-rooted challenges that cannot be resolved fiscally.

The intended recapitalisation of SAA to the amount of R5 billion, the SA Post Office at R2.9 billion and SA Express at R1.2 billion is potentially a repeat of unsustainable policy choices that the fiscus is increasingly unable to support.

While the risks to the economy and fiscus arising from allowing these and other entities to default on debt must be borne in mind, there remains the underutilised and increasingly necessary alternative of disposing of non-core assets through the partial or full privatisation thereof.

Although National Treasury acknowledges the risks to the fiscus posed by SOEs and the state’s exposure in the form of contingent liabilities, there is little prospect of mitigation thereof in the absence of substantial reform.

In this, Eskom features prominently: its recent wage settlement, granting increases well in excess of consumer price inflation, along with continued losses, increasing interest costs and its qualified audit pose questions about the sustainability of a vertically integrated, state-owned monopoly electricity utility.

Whether the positive signalling reflected in the 2018 MTBPS is sufficient to convince ratings agencies and investors to respond positively, despite the deterioration in the fiscal outlook over the medium term, remains to be seen.

At best, an all-important reprieve from immediate sovereign ratings downgrades has been earned, but the success of the government’s fiscal consolidation efforts will depend on its ability to sustainably implement the growth-enhancing reforms needed to grow the economy and advance socioeconomic development.

There remains significant scope for further, much-needed regulatory and structural reform in addition to that announced in the MTBPS.

The 2019 national budget will therefore be crucial not only in terms of demonstrating the earnest implementation of stated reforms, but also in creating further conditions for growth.

Serrao is Business Unity SA’s economic and trade policy director

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September 15 2019