21 Aug 2018

2018's Budget Snapshot

Annabel Bishop

Chief Economist

Likely enough to avoid a Moody’s Q1.18 downgrade

fig1-budget-snapshot-22-02-2018
  • Following years of increasingly tight Budgets, where net debt has escalated from 18% of GDP in 2008/09 to an estimated 46% of GDP for 2017/18, the fiscal (budget) deficit has risen from -1.2% of GDP to an estimated -4.3% of GDP in the same period as expenditure has climbed from R0.7trn to R1.6trn as revenue lagged (R0.7trn to R1.4trn). 2018’s tabling of the Budget was always likely to show a tough fiscal environment.
  • Turning this story around now, with the projected fiscal deficit falling to 3.5% GDP by 2020/21 (the end of the MTEF), coupled with the gross debt projections stabilising at 56% of GDP and then falling to 55% by 2025/26 (versus the 63% presented in the 2017 MTBPS), has likely made SA’s projected government finances more palatable to the rating agencies, and could be enough to avoid a Moody’s downgrade.  
  • Indeed, Moody's has said that SA has made a number of credit positive strides since December 2017, and today’s Budget, on its own does not necessarily argue for a credit rating downgrade. Certain components of the Budget are credit positive, especially the marked decline in projected borrowings. The primary balance sees a projected surplus from 2018/19 and the current deficit tends towards 0% (if not fractionally below), while debt service costs for 2020/21 are lower than in the MTBPS. 
  • The R186 has seen considerable strength, at 8.08% yesterday from 8.58% at the start of the year, and now currently trading at 8.00% after dipping to 7.97% on the release of the budget, as the  Budget has not seen supply issuance of government debt over the 2017 Budget, with the later evidencing more fiscal consolidation than in the MTBPS.   
  • The rand has performed poorly over most of this week, from R11.58/USD, R14.28/EUR and R16.23/GBP over the weekend on the outcome of the SONA to R11.78/USD, R14.52/EUR and R16.43/GBP as the US dollar has strengthened to 1.23 to the EUR from 1.26/EUR. 
  • However, the domestic currency has gained today on the perceived reasonable outcome of 2018’s Budget, sufficient on its own not to necessarily precipitate a credit rating downgrade from Moody’s, or any of the other two key credit rating agencies (Fitch and S&P). Moody’s is expected to deliver judgement on or before 23rd March. Looking forward, the expected cabinet reshuffle is the next event which could provide further support to investor sentiment and the rand. 
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  • As part of fiscal measures to narrow the budget deficit and stabilise debt growth, government proposes to raise an additional R36billion in revenue in 2018/19, which along with expenditure cuts will reduce the budget deficit, and fund the free education announced for poor and working class students . Proposals to raise another R15 billion in both 2017/18 and 2018/19 will be put forward in future budgets.
  • The value-added tax (VAT) rate is increased by 1% to 15% and ad valorem excise duties for luxury purchases are increased while the top four personal income tax brackets are not be adjusted for bracket creep (inflation), and estate duty rises for estates worth more than R30 million. Government reiterates that it will continue to strengthen its efforts to combat base erosion and profit shifting.
  • VAT will increase the cost of living for South Africans, and we estimate a rise of at least 0.1% in CPI inflation over the lst three quarter of this year and the first quarter of next, although the prior rand strength and lower fuel price increases have reduced the CPI inflation forecast for 2018 somewhat. CPI inflation should come out around 5.0% y/y this year and 5.3% y/y in 2019.
  • South Africa’s declining tax buoyancy has declined on weak economic growth, leading to the decision not to adjust income taxes further, while recognition was also given to last year’s increase in income taxes, and the lengthy period which has passed since a VAT increase (1993).  
  • Specifically, National Treasury says “(a)n additional personal income tax rate increase in 2018/19 would have greater negative consequences for growth and investment than a VAT increase. Moreover, significant shortfalls from this tax (personal income tax) in 2017/18 suggest that further increases might not yield the revenue required to stabilise the public finances.”
  • Corporate tax in SA was not adjusted as this tax has been falling in advanced and middle income countries and increasing it would reduce SA competitiveness globally, and have a negative growth impact. Indeed, “(t)his trend limits the room to increase (or even maintain) the tax rate on business. Corporate income tax contributes more as a share of GDP in South Africa than in most other countries. Within the Organisation for Economic Cooperation and Development (OECD), only companies in Chile contribute a higher share.”
  • The US has reduced its corporate tax rate from 35% to 21% and the UK from 30% to 19%, while at 28% SA’s corporate tax rate is increasingly becoming an outlier, even to many other African countries who often reduce their corporate tax rates effectively with mechanisms such as incentives, tax holidays etc. Consequently, government will review the controlled foreign company tax exemption to determine whether a reduction is warranted.
  • Furthermore, “(g)overnment is reviewing the tax treatment of excessive debt financing. The deductibility of interest payments on debt acts as an incentive to use debt rather than equity funding, and can be used to strip profits from high-tax countries. A discussion document inviting comments will soon be published to facilitate public consultation. Government is striving for a balance between certainty, simplicity and adequate base protection to ensure a sustainable corporate tax base.”
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  • SA managed to reduce its huge budget deficit it inherited, of above 6% in 1994 to a fiscal surplus in the 2000s, engendering tax cuts, credit rating upgrades to an eventual A grade status and strong economic growth and notable SOE infrastructure investment.
  • Key to this substantial consolidation of public finances was substantially increased efficiency and collections at SARS, and tax administration. 
  • On SOEs and their governance, this year’s Budget says “in order to ensure proper governance of public entities and encourage accountability, government proposes that losses or expenditure classified as fruitless and wasteful will not qualify for a tax deduction”. The credit rating agencies have highlighted governance at SOEs as a key concern.
  • The focus in the 2018 Budget came on changes to enhance tax administration, with SARS to release “a discussion paper on the potential use of electronic fiscal devices, sometimes known as electronic cash registers, to help revenue administration by monitoring business transactions.”
  • “Amendments to the Customs and Excise Act (1964) will be considered to prevent “forestalling” – a practice through which abnormal volumes of products are moved from warehouses into the market to avoid increases in excise duty rates.
  • Legislative changes will be made to the Customs and Excise Act to extend the use of “fiscal markers”, which are required under the tracking and tracing obligations of the World Health Organisation’s Protocol to Eliminate Illicit Trade in Tobacco Products. The extension will enable fiscal marking of other products.
  • SARS, which collects more than 30 per cent of total revenue from the customs and excise system, is at an advanced stage in implementing its customs modernisation programme, and strengthening data and revenue collection associated with cross-border trade.”
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  • In line with Davis Tax Committee recommendations and the progressive structure of the tax system, estate duty will rise from 20% to 25% for estates worth R30 million and more. To limit the staggering of donations to avoid the higher estate duty rate, any donations above R30 million in one tax year will also be taxed at 25 per cent. Both measures are effective from1 March 2018.
  • Over the next three years below-inflation increases in medical tax credits will help government to fund the rollout of national health insurance. The medical tax credit rises from R303 to R310 per month for the first two beneficiaries, and from R204 to R209 per month for the remaining beneficiaries. 
  • Government proposes to increase the general fuel levy by 22c/litre and the Road Accident Fund levy by 30c/litre, effective 4 April 2018.
  • Government proposes to increase excise duties on tobacco products by 8.5 %, and excise duties on alcohol by between 6 % and 10 %. 
  • The Carbon Tax Bill in August 2017 is expected to be enacted before the end of 2018, with the tax implemented from 1st  January 2019 to the 2015 Paris Agreement of the United Nations Framework Convention on Climate Change.
  • The plastic bag levy is to be increased by 50 per cent to 12 cents per bag, effective 1 April 2018, and the environmental levy on incandescent light bulbs will increase from R6 to R8 also from 1 April 2018.
  • The vehicle emissions tax will be increased to R110 for every gram above 120 gCO2/km for passenger vehicles and R150 for every gram above 175 gCO2/km for double cab vehicles, effective 1 April 2018.
  • The health promotion levy, which taxes sugary beverages, will be implemented from 1 April 2018.
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  • Government has examined areas to support economic growth initiatives, although little fiscal space is currently available for substantial relief or support. South Africa will need to improve on this area to drive faster economic growth and job creation. The announcements in the 2018 Budget include:
  • “The Minister of Finance will approve six special economic zones to benefit from additional tax incentives. … Coega, Dube Trade Port, East London, Maluti-a-Phofung, Richards Bay and Saldanha Bay will offer attractive incentives, including a reduced corporate tax rate for qualifying firms and an employment tax incentive for workers of all ages. The legislation will be reviewed to ensure that the granting of these additional tax incentives does not create opportunities for local companies to shift their activities and reduce their tax liability.”
  • “Research and development (R&D) can lead to innovation, increased productivity and higher levels of economic growth. To encourage greater investment, the R&D tax incentive allows taxpayers to deduct 150 per cent of expenditure on qualifying projects. Over the past two years, the Department of Science and Technology has worked to reduce an application backlog that developed due to inefficiencies in the system, and has moved to an online system. Government will consider revising aspects of the legislation that have created complexity.”
  • “The employment tax incentive appears to have had generally positive results, depending on firm size. Impact analyses consistently find high impact in smaller firms, with lower or negative impacts in large firms. The incentive will be reviewed before it expires on 28 February 2019.”
  • “The venture capital company tax incentive provides a tax deduction for buying shares in venture capital companies, which in turn invest those funds in qualifying small businesses. Increased equity funding in small businesses enables them to expand and contribute to economic growth and job creation. The incentive has been in place since 2008. Following recent amendments, the incentive has seen a substantial increase in take-up. From only one in 2008, there are now more than 90 registered venture capital companies with total investments of R2.5 billion.” 
  • “Investment in qualifying small businesses amounts to R615 million. New and existing small businesses in all economic sectors are benefiting from funding, enabling them to hire staff and grow their businesses. An administrative amendment to the incentive is discussed in Annexure C, and legislation will be tightened to reduce the scope for tax structuring.”
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  • One of the most important turn arounds in the 2018 Budget compared to the 2017 MTBPS is that “(t)he 2018 Budget proposes major spending adjustments and tax measures in response to the unsustainable debt outlook presented in the October 2017 Medium Term Budget Policy Statement (MTBPS). Together with faster economic growth, these measures serve to reduce the budget deficit and stabilise national debt as a share of GDP over the medium term.”
  • Two major spending changes occur compared to the 2017 MTBPS, namely “cuts identified by a Cabinet subcommittee amounting to R85 billion over the medium term, and an additional allocation of R57 billion for fee-free higher education and training. Contingency reserves have been increased to reflect uncertainty in the growth outlook, spending pressures and the precarious finances of several state-owned companies.:
  • Indeed, National Treasury says “(t)he economic and fiscal outlook has improved since the October 2017 MTBPS. Investor confidence has grown on the promise of renewed policy coordination and effective implementation. Yet the challenges highlighted in October – rising national debt, significant revenue shortfalls and the precarious financial condition of several state-owned companies – remain central policy concerns.” These are likely to also be the sentiments of the credit rating agencies, and Moody’s in particular may now give SA additional time to get its finances in order, instead of delivering a downgrade to junk status after this budget as was feared.
  • SA’s 2018 Budget shows lower than previously projected deficit figures and a stabilisation of debt over the medium term period, where the budget deficit falls to -3.5% of GDP by the end of the period from the MTBPS’s estimate of -3.9%. Projected revenue collection for 2017/18 is projected R2.6bn higher than in the October 2017 estimate, but compared to the budget in 2017 leaves a shortfall of R48.2bn.
  • The expenditure ceiling has been revised marginally down over the medium term but rises by R2.9bn in 2017/18 “as a result of the recapitalisation of South African Airways (SAA) and the South African Post Office. These appropriations total R13.7 billion, partially offset by the use of the contingency reserve and projected underspending.”
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  • Specifically, the expenditure cuts totalling R85 billion over the MTEF period show “about R53bn has been cut at national government level, including large programmes and transfers to public entities. At subnational level, conditional infrastructure grants of provincial and local government have been reduced by R28 billion. In addition, all national and provincial departments were required to reduce their spending on administration. The reductions exclude compensation of employees, which is already subject to a ceiling.
  • The major additions to the framework following the 2017 MTBPS are: Allocations to fee-free higher education and training for poor and working-class students amount to R12.4 billion in 2018/19, R20.3 billion in 2019/20 and R24.3 billion in 2020/21. This is in addition to a R10 billion provisional allocation made in the 2017 Budget.
  • Allocations of R4.2 billion for national health insurance funded through adjustments to the medical tax credit, R490 million to establish the Tirisano Construction Fund Trust and R1 billion for the 2021 census.
  • An additional amount of R2.6 billion to enable an above-inflation increase to social grants to partially offset the impact of tax increases on the poor.
  • A provisional allocation of R6 billion set aside in 2018/19 for drought relief in several provinces, assistance to the water sector, and public investment projects supported by improved infrastructure planning.
  • Additions of R5 billion in 2018/19, R3 billion in 2019/20 and R2 billion in 2020/21 for fiscal risks and unforeseen developments, bringing the total contingency reserve to R26 billion over the medium term.”
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