Finance minister Enoch Godongwana delivered his much-anticipated national budget on Wednesday after its unprecedented postponement from February 19. The bone of contention centred on disagreements between the members of the government of national unity (GNU) on a proposal to increase VAT by two percentage points to 17%.
In the revised budget the minister tabled a more moderate 50 basis-point increase this year and another next year, taking the VAT rate to 16% in the next fiscal year. However, some concessions include cutbacks in planned increases on social grants, as well as not providing any inflationary relief on income tax, which will result in bracket creep — and a loss in real wage growth and even nominal growth for some.
Though there are some tax-relief proposals, including increasing the number of zero-rated items, which will also help counter the regressive nature of VAT, and no inflationary increases for fuel levies, overall the new tax regime is set to increase revenue by more than R100bn over the next three years.
The challenge the finance minister faces is ensuring fiscal stability, containing the wage bill, managing debt levels and continuing infrastructure spend — on water, energy and transport in particular — while increasing the allocation to economic development, which should generate revenue.
The reality is a lot of the elements that drive the fiscus can only be driven from a government perspective; optimised government structures, self-sufficient and even profitable state-owned enterprises with limited fiscal leakages.
There is simply no further appetite from capital markets to continue kicking the proverbial can down the road. Over the past 15 years our debt-to-GDP level has grown from below 30% to about 75%, with each budget forecasting debt stabilisation over an endless three-year rolling period.
Over this same period we have seen the cost of servicing debt being the fastest-growing expenditure item, doubling its share of government’s spending allocation, along with downgrades from all three major credit ratings agencies to subinvestment grade and bond yields rising by more than 300 basis points.
As unpopular as these decisions may be, it is the first time in a long time that we expect debt levels to stabilise in the current fiscal year and that the cost of servicing debt is no longer the fastest-growing expenditure item, overtaken by economic development. The primary budget, excluding the cost of servicing debt, is in surplus and expected to continue, which should aid the debt containment initiatives.
Nonetheless, the VAT debates and pushbacks have certainly been healthy. It is essential that this tough balancing act by the finance minister is challenged, otherwise raising taxes and finding unsustainable sources of revenue becomes an easy way out to fiscal consolidation.
In previous years we have simply accepted the spending of emergency reserves and the gold and foreign currency reserve as rabbits out of a hat, but these are not sustainable.
We now have to pay the price as citizens, unfortunately, but this too is unsustainable, particularly with the high levels of structural unemployment and poverty, as well as a stretched dependency ratio between taxpayers and the rest of the population.
Furthermore, if history is anything to go by the projected additional tax revenue from changes in the tax regime is seldom fully achieved. SA Revenue Service (Sars) commissioner Edward Kieswetter has previously estimated the tax gap between what is collected compared to what should be to be as high as R800bn. Efforts towards closing this gap have been highlighted with additional allocation to Sars.
Though the tax proposals will proceed there is pressure to get the rest of the budget approved by parliament within 16 days. In the event it is not approved, spending allocations will revert to last year’s budget until a new one is approved.
In the longer term, there are upside risks to spending, which include the wage bill, state-owned enterprises, infrastructure projects, the social relief of distress grant and reduced aid from the US on healthcare, among other things. A stronger emphasis should be placed on implementation of the promised fiscal reforms and consolidations by government, which is the sustainable solution we need.
Market reaction has been largely muted, with a lot of noise coming from increased global geopolitical tensions offset by local improving fundamentals. Looking ahead, we believe the financial sector will do well in this environment, as well as the retail sector to some extent, though we are mixed on retail, particularly given the strong rallies we have already seen.
We also believe the precious metals mining sector will do well, while industrial mining is likely to lag as a result of a struggling Chinese property market and steel producer tariffs from the US. Overall, we find local equity market valuations attractive, even with the risk of an overly squeezed consumer.
• Smith is chief investment officer at Absa Investments.
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