The world is changing fast and to keep up you need local knowledge with global context.
From the STANLIB Economics Team
The South African Minister of Finance, Enoch Godongwana, delivered his second National Budget on Wednesday, 22 February 2023, having been appointed as Minister of Finance in August 2021.
Unfortunately, South Africa’s macro-economic environment remains extremely challenging. This is reflected in a range of social and economic factors including extremely high unemployment, weak consumer and business confidence, low fixed investment, high inflation, rising interest rates, failing infrastructure (most especially the persistent electricity outages) and a weakening exchange rate.
This severely limits the Minister of Finance’s policy choices, especially given the country’s need to attract and retain foreign investment as well as avoid any further credit rating downgrades.
South Africa urgently needs to alleviate its persistent and severe electricity constraints
The South African economy continues to stagnate, trapped by the persistent lack of a reliable electricity supply, and the ongoing deterioration of South Africa’s infrastructural capacity – including rail and port capacity. The negative impact of electricity outages combined with key infrastructural breakdowns is reflected in the performance of South Africa’s mining and manufacturing sectors. In particular, mining production declined by an average of 7.2% in 2022, while manufacturing activity fell by -0.3, with output far below the peak level of activity achieved in 2008.
In addition, rising interest rates, declining real household incomes and weak consumer confidence is systematically undermining consumer activity. For example, retail spending has struggled to gain momentum over the past year, recording a monthly average decline of -0.1% in 2022. In fact, since January 2022 South Africa’s retail spending has fallen by -2.5% in real terms and is -1.6% below the level of retail activity that prevailed one month prior to the onset of COVID-19.
Ultimately, without a meaningful and sustained increase in the overall level of fixed investment spending and employment, South Africa’s economic activity will struggle to gain momentum, limiting the growth of South Africa’s tax base, and by implication, limiting government’s ability to implement meaningful socio-economic reforms.
The 2023/2024 budget numbers
For the 2023/24 fiscal year the Minister of Finance announced that the budget balance is projected to improve slightly to -4.0% of GDP, down from a revised -4.2% of GDP in 2022/2023. Crucially, in 2024/2025 the fiscal deficit is expected to continue to improve, dropping to -3.8% of GDP, before reaching an acceptable -3.2% of GDP in 2025/26. These projections confirm that the Minister intends to adhere to fiscal discipline over the medium term, although he acknowledged that it would still take several years before the level of government dent is at a comfortable and sustainable level.
Impressively, he also highlighted that they expect to be able to achieve a primary budget surplus (which is the budget deficit less interest costs) in 2022/2023 and then sustain a primary surplus for the foreseeable future.
Overall, the government’s deficit projections are well ahead of market expectations, and as mentioned above, confirm government’s intention to adhere to fiscal discipline. In other words, a primary surplus will go a long way towards convincing the public, investors, and credit rating agencies that government is serious about its intention to maintain a disciplined fiscal framework.
Unfortunately, it should also be noted that in the prior years, government persistently aimed to reduce the budget deficit to below -3% of GDP on a sustained basis, but was clearly unable to meet the target, largely because of weak economic growth and an inability to reign-in government expenditure, especially consumption spending and salary expenses. Hopefully, this time is different.
In that regard, investors need to be mindful of two risks. The first is that government’s revenue projection appear ambitious in a low growth environment and the second is that government has budgeted for a very modest increase in salary payments, which are likely to be exceeded once the negotiations for the public sector trade unions have been completed.
Lastly, the Minister of Finance is forecasting that SA GDP with growth by only 0.9% in 2023, which is down from 2.5% in 2022 and below prior estimates of SA’s likely growth performance. The projected slowdown in economic growth will make it extremely difficult for government to achieve their budgeted level of fiscal consolidation. Furthermore, given the current balance sheet constraints within central government as well as SOE sector, economic policy will have to increasingly focus on the role of the private sector in driving economic growth. We hope this includes a greater reliance on private-public partnerships as a means of lifting fixed investment spending.
The revenue side of the budget
In 2022/2023, tax revenue out-performed budget by an estimate R93.7 billion, implying that total revenue increased by a substantial 8.2% year-on-year. This follows an out-performance of R198.6 billion in 2021/22. The current level of tax collection is the highest ever recorded, despite the country’s weak economic performance and high level of unemployment.
A breakdown of the 2022/23 tax revenue windfall highlights that while the over-collection was broad-based, the biggest surge in revenue was due to corporate taxes (R75 billion ahead of the initial budget), followed by individual tax collection (R13.7 billion over budget), customs duties (R13.1 billion) and excise duties (R4.3 billion). On a negative note, while most tax categories outperformed the 2022 Budget, net VAT collection was below expectations, coming in R13.4 billion below the government’s initial projection. This was because government paid out larger-than-expected VAT refunds for zero-rated manufactured exports. Overall, government paid out R62.8 billion more in VAT refunds in 2022/23, reducing the overall VAT collection performance. In addition, the fuel levy fell short by R10 billion due to fuel levy relief during the first half of 2022.
The growth in corporate tax was driven by strong tax collections from the mining sector amid elevated commodity prices. Importantly, the finance industry and manufacturing sectors also exceeded expectations, despite weak economic growth. According to the 2023 Budget, a portion of the revenue improvement is also due to improved tax compliance and tax administration by SARS. While the recent improved revenue performance is extremely welcome, there is a lot of uncertainty regarding the sustainability of the current level of tax receipts, especially the surge in corporate tax receipts amid a sustained fall in mining production, declining terms of trade, stagnant domestic activity, and weaker global economic growth.
It is fair to argue that the exceptionally large tax receipts over the past two years mean the fiscal authorities were not forced to seek additional tax revenue through substantial tax hikes. Instead, the Minister recognised the financial strain that households were under and provided some relief, announcing only modest tax changes, which is in sharp contrast with some prior years.
Fortunately, and very positively, during the 2023/2024 budget the Minister avoided any surprise tax adjustments. In fact, the Minister provided relief for households from the impact of fiscal drag as well as increases to medical tax credits. This should provide individuals with R15.7 billion in tax relief, especially lower‐ and middle‐income households. For example, because of the adjustment to the tax thresholds, a person earning R250 000 will pay R1 698 less tax for the year (a -5.6% reduction) while a person earning R1 million will pay R5 527 less (a -1.9% reduction). While this was expected and the amounts are modest, they are welcome as they help to ease some of the pressure on individuals and provides relief from the damaging impact of inflation.
In addition, in an effort to further reduce the burden on households, the minister announced no changes in the general fuel levy or Road Accident Fund levy.
Other meaningful tax changes in 2023/2024 include further, but unsurprising, increases in the usual array of excise duties, especially on cigarettes and alcohol. Positively, however, instead of increasing these levies by above inflation as usual, the minister only increased excise duties on alcohol and cigarettes by 4.9%, in line with expected inflation.
The Minister did, however, provide a welcome tax incentive to encourage the installation of renewable energy by households and businesses. From a business sector perspective, the renewable energy tax incentive was expanded so that business can claim a 125% deduction over 2 years for all renewable energy projects with no thresholds on generation capacity. In addition, the National Treasury introduced amendments to the Bounce-Back Loan Scheme to include energy-related applications.
For households, individuals will be able to receive a tax rebate of 25% of cost of any new and unused solar PV panels (up to a maximum of R15 000 per individual) during the next year, starting in March 2023. This is a welcome incentive, and a better-than-expected outcome especially for businesses given that the incentive has no limit and can be claimed over 2 years. Unfortunately, the benefit for individuals is less emphatic as it mostly targets those who can afford to install solar and places a relatively low limit on how much can be claimed back.
For 2023/2024 the Minister intends to collect R1.79 trillion in tax revenue, which is an increase of 5.6% relative to 2022/2023. While this appears largely achievable, as it only implies a tax buoyancy of 1.06, there are significant risks surrounding government’s tax collection projections over the medium term. Furthermore, the tax revenue projections over the medium term seem ambitious, with gross tax revenue growth projected to average 6.5% for the three years to 2025/26, given the high base in 2022/2023, as well as sluggish economic growth.
The expenditure side of the budget
The projected additional revenue enables government to respond to some immediate spending pressures while continuing to stabilise the public finances. Despite the headwind, government has remained relatively conservative on its expenditure projections. In 2023/2024 government is budgeting to spend R2.24 trillion, which is a modest rise (3.4%) considering that over the past five years government expenditure has increased by an annual average of around 7.1%. The bulk of government’s spending is still allocated to education at R451.2 billion or 20.2% of total expenditure, followed by social protection at R385.6 billion (17.2% of expenditure) and healthcare at R255.0 billion (11.4% of expenditure).
Unfortunately, one of the fastest-growing areas of government spending remains debt servicing costs, which is projected at 15.2% of total expenditure in 2023/2024, up from 11.3% at recently as 2019/20
Unfortunately, there is still not enough in the budget to directly promote job creation, although it shows that government is continuing on its path for fiscal consolidation by making sure that expenditure remains reasonable.
This is shown by the fact that the Minister provided for a moderate increase in social payments. The money allocated to social development will be spent on the various support programmes, reaching a combined total of 19.6 million (excluding people claiming the social relief of distress grant) out of a total population of 60.6 million.
For the 2023/24 financial year, grant increases are largely in line with inflation expectations. Specifically, they will be adjusted as follows:
- Old Age increases by 5.0%
- War Veterans increases by 5.0%
- Disability and care dependency grants increase by 5.0%
- Foster Care increases by 5.1%
- Child Support Grant increases by 5.2%
The recently extended Social Distress Grant has been allocated R36.1 billion for another 12 months. The relief provides R350 to unemployed South Africans and came into effect at the onset of the COVID-19 pandemic.
Adjustments to the public sector wage bill
Government’s intention to contain salary increases remains a key focus area in this year’s budget. Over the last 10 years, compensation of public sector employees has become one of the largest components of government spending. Back in 2018/2019 this accounted for a substantial 35.6% of total consolidated expenditure, but decreased to 31.8% in 2022/2023, and is expected to decrease further to 31.3% by 2025/26. While the Minister acknowledged the importance of public servants for the delivering of public services, he underscored the need to curtail compensation spending to increase the allocation of resources to capital expenditure.
Despite a move in the right direction, South Africa’s wage cost remains exceptionally high by international standards. Furthermore, while the Minister has clearly outlined government’s intention to control salary expenses, it is somewhat unclear as to whether this plan can be achieved – especially given the push-back from the major public sector trade unions and the uncertainty around possible wage settlements which have not been considered for the Budget. The wage bill growth is projected to average 3.3% over the medium term, well below the 4.9% average inflation for the period, representing one of the biggest risks to the National Treasury’s expenditure projections.
Eskom Debt Relief Arrangements
During last year’s budget the Minister of Finance made it clear that to reduce demand on limited public resources, state-owned companies need to develop and implement sustainable turnaround plans that align with their mandates, incorporate long-term structural considerations in their sectors and identify appropriate funding modes. In addition, it was announced that the Presidential State-Owned Enterprises Council is developing a new approach to government’s management of these companies: some will be retained, while others may be disposed of or consolidated. The future of state-owned companies will be informed by the value they create and whether they can be run in a sustainable manner.
With that in mind the Minister announced a debt relief arrangement to help Eskom out of its current unsustainable financial position. Over the next 3 years, the government has committed to provide Eskom with debt relief of R254 billion; R168 billion in capital payments and R86 in interest payments. This will take the form of advances of R78 billion in 2023/24, R66 billion in 2024/25 and R40 billion in 2025/26. These amounts represent Eskom’s full debt settlement requirement over the next 3 years, accounting for almost 40% of Eskom’s total debt (excluding the expected interest payments). This arrangement will be financed through the R66 billion MTEF baseline provision and R118 billion in additional borrowing over the next 3 years. In addition, government will directly take over up to R70 billion of Eskom’s loan portfolio in 2025/26.
In order to receive this bail-out, Eskom will need to adhere to a range of strict conditions that include being forbidden from taking on new debt during debt-relief period, unless written permission is granted by the Minister of Finance; and limiting capital expenditure to transmission and distribution related projects. In addition, the National Treasury is considering proposals to address the R56.3 billion outstanding debt owed to Eskom by municipalities.
In terms of other SOEs, National Treasury has allocated additional financing to the following:
- SAA is allocated an additional R1 billion during 2022/23 to assist the carrier with the business rescue process.
- The South African Post Office is allocated R2.4 billion to implement its turnaround plan.
- No further allocations were made to Denel, Transnet and SANRAL beyond what was announced during the 2022 MTBPS.
Outside of Eskom, there was no restructuring of other SOEs announced in this budget. This increases the risk that a number of these fragile SOEs will need government assistance as the year progresses, placing pressure on government’s expenditure outlook.
Debt servicing costs continue to rise, but at a more modest pace
As mentioned earlier, South Africa’s public sector debt and debt servicing costs have escalated dramatically in recent years. In particular, government debt jumped from 57.2% of GDP in 2019/2020 to 70.2% of GDP in 2020/21, while the interest cost of state debt rose sharply to almost 19% of total tax revenue. This meant that the cost of state debt was the fastest rising element in the budget, highlighting the need for government to contain the fiscal deficit to reduce total debt as a percentage of GDP.
Under these circumstances, a significant rise in bond yields, for whatever reason, would put South Africa’s fiscal position under increasing strain. Already the cost of debt exceeds the total budget allocation for key government departments including public order and safety, healthcare, and housing development.
Very encouragingly, the better-than-expected revenue outcome over the past two years coupled with government’s decision to apply some of the revenue windfall to debt reduction, means that government’s gross debt to GDP is now projected to peak at around 73.6% of GDP in 2025/26, which is significantly down from the October 2020 estimate of around 95%. At the same time the debt servicing costs are projected to rise modestly over the coming years, remaining below 20% of tax revenue – despite government’s decision to bail-out Eskom to the value of R254 billion over the next three years. In other words, while government debt and the associated debt services costs remain substantial and uncomfortable high, the deterioration is being contained, with government debt projected to fall to around 65% of GDP by 2030/31.
Overall, the Minister of Finance presented a sensible budget under difficult economic conditions, although the continued tax revenue windfall made the Minister’s job significantly easier. In that regard, it is encouraging that the Minister did not attempt to deliver an outright politically expedient budget given the National Election in 2024, nor was there any shock tax announcements. Instead, the Minister re-iterated the need to control expenditure over the medium term, while continuing the path of fiscal consolidation. In that regard, the success of this year’s budget will be determined by government’s ability to maintain fiscal discipline, while at the same time ensuring that key policy initiatives are implemented much more effectively.
It is also clear that government’s debt issuance should remain manageable, especially given the conservative approach that National Treasury continues to adopt in ensuring that debt issuance is undertaken proactively and that they retain a large cash portion.
Although several policy options are available to revitalise the South African economy in the medium-term and therefore improve government finances, the range of workable solutions have diminished substantially over the past ten years given the destruction of the public sector’s balance sheet and the weakening of key public sector institutions, including many SOEs.
At this stage, apart from trying to resolve the ongoing electricity crisis, the most viable policy initiatives would still include substantially expanding the use of private-public partnerships, the extensive deregulation of the business sector in a concerted effort to make it easier to do business and lift business confidence, a turnaround strategy for failing municipalities, a demonstratable focus on restoring good governance (including successful prosecutions), and the urgent reorganisation of South Africa’s fragile rail and port capacity.
STANLIB Economics Team
Cyril Ramaphosa: The Audio Biography
Listen to the story of Cyril Ramaphosa's rise to presidential power, narrated by our very own Alec Hogg.