Mini Budget Shockers: Tax shortfall hits R51bn, debt-to-GDP skyrocketing, Telkom sale on cards

PRETORIA — Finance Minister Malusi Gigaba got off to a rocky start in his debut Medium Term Budget Policy Statement on Wednesday. He faces the country’s biggest ever tax revenue shortfall since 2009 (a massive R50.8bn) as well as a rising debt-to-GDP ratio which is currently at 54.2% but which is forecast to top 61% by 2022. In his maiden budget speech, Gigaba tries to inspire South Africans by acknowledging the country’s economic woes while speaking up the need to spur on GDP growth to the National Development Plan’s goal of over 5% per annum. South Africa is currently a far cry from that goal as Treasury today also revised growth for 2017 downwards from 1.3% to 0.7%. In his speech, Gigaba largely steers clear of controversy by sidestepping nuclear and by toning down references to the ANC’s ‘radical economic transformation’ rhetoric. But today is a baptism of fire for Gigaba and, from a journalist’s perspective, things inside Pretoria’s Treasury building on Mini Budget day weren’t operating as smoothly as previously. I attended Treasury’s media lock-up in Pretoria and Gigaba missed a key media briefing scheduled for earlier in the day in Cape Town. He rescheduled around midday, but this played havoc with journalists’ deadlines. Amid these reporting challenges, below is a summary of key highlights in the 2017 mini budget, sourced from Gigaba’s speech and Treasury documents. – Gareth van Zyl

Malusi Gigaba, South Africa’s finance minister. Photographer: Waldo Swiegers/Bloomberg

Summary of the MTBPS from Finance Minister Malusi Gigaba’s 2017 budget speech.

To summarise key points about the economic outlook and the fiscal framework in this MTBPS:

  • Conditions in the global economy continue to improve, but the risks of financial turbulence remains high, and the long-term outlook for growth and commodity prices remains muted.
  • The 2017 Budget projected GDP growth of 1.3 per cent in 2017. Our growth forecast for this year has been revised downward to 0.7 per cent. We forecast growth of 1.1 per cent in 2018, and 1.5 per cent in 2019.
  • Due to lower than expected economic growth this year, gross tax revenue for 2017/18 is projected to be R50.8 billion rand lower than projected in the Budget.
  • The consolidated budget deficit will widen to 4.3 per cent of GDP in 2017/18, against a 2017 Budget target of 3.1 per cent of GDP.
  • Gross national debt is projected to reach 61 per cent of GDP by 2022, with debt-service costs approaching 15 per cent of main budget revenue by 2020/21
  • Government aims to resolve the setback in fiscal consolidation by: paring down the contingency reserve over the MTEF; cutting into the deficit with fiscal efforts to be announced in the 2018 Budget; kick-starting higher economic growth by implementing confidence-boosting measures and implementing reforms; and maintaining the expenditure ceiling.
  • The expenditure ceiling is threatened in the current year, as a result of government’s recapitalization of South African Airways and the South African Post Office. Government is disposing of a portion of its Telkom shares to avoid a breach, with an option to buy them back at a later stage.
  • Infrastructure investment will amount to R948 billion over the next three years
  • Efforts to improve supply chain management and achieve value for money in government spending will continue.

Unpacking the Mini Budget

(**Below are further highlights from today’s MTBPS announcement that I’ve put together from Treasury’s documents. This is all quoted directly from Treasury documents:)

Tax revenue is projected to fall short of the 2017 Budget estimate by R50.8 billion in the current year, the largest under-collection since the 2009 recession.

At the same time, additional appropriations of R13.7 billion have been agreed to forestall calls against guaranteed debt by the creditors of South African Airways (SAA) and the South African Post Office.

Debt levels have risen as economic growth and revenue collection have deteriorated. These are partially offset by use of the contingency reserve, as well as projected underspending.

Gross loan debt is expected to increase from R2.5 trillion or 54.2 per cent of GDP in 2017/18 to R3.4 trillion or 59.7 per cent of GDP in 2020/21. Absent higher economic growth or additional steps to narrow the budget deficit, the debt-to- GDP ratio is unlikely to stabilise over the medium term.

The economic outlook has deteriorated significantly since the beginning of the year. Gross tax revenue for the 2017/18 – 2019/20 period is projected to fall short of the 2017 Budget estimates by R209 billion.

  • The consolidated budget deficit will widen to 4.3 per cent of GDP in 2017/18, against a 2017 Budget target of 3.1 per cent of GDP. Gross national debt is projected to reach over 60 per cent of GDP by 2022, with debt service costs reaching 15 per cent of main budget revenue by 2020/21.
  • The expenditure ceiling could be breached by R3.9 billion in the current year, mainly as a result of government’s recapitalisation of South African Airways and the South African Post Office. Government is considering the disposal of assets to offset these appropriations during the current year.
  • Additional risks to the framework include more financial demands from state-owned companies, public service compensation pressures and new spending commitments, particularly in higher education.
  • A presidential task team is considering a range of steps to bring the public finances back onto a sustainable path. Announcements will be made at the time of the 2018 Budget.

Tax revenue is projected to fall short of the 2017 Budget estimate by R50.8 billion in the current year, the largest under-collection since the 2009 recession.

At the same time, additional appropriations of R13.7 billion have been agreed to forestall calls against guaranteed debt by the creditors of South African Airways (SAA) and the South African Post Office.

Debt levels have risen as economic growth and revenue collection have deteriorated. These are partially offset by use of the contingency reserve, as well as projected underspending.

Factors contributing to poor revenue performance

The lower outcomes in 2016/17 explain part of the shortfall in the current year. However, revenue growth has remained weak, even as the economy emerged from recession in the second quarter of 2017. For the first six months of 2017/18, gross tax revenue grew by 5.9 per cent year-on-year against a target of 10.7 per cent.

All tax instruments are performing poorly, with large shortfalls for personal and corporate income tax, and dividend withholding tax. The National Treasury projects a tax revenue shortfall of R50.8 billion in 2017/18 compared with the 2017 Budget estimate.

These assumptions produce gross tax revenue projections that fall short of 2017 Budget estimates by R50.8 billion in 2017/18, R69.3 billion in 2018/19 and R89.4 billion in 2019/20.

Weak GDP growth

The 2017 Budget projected GDP growth of 1.3 per cent in 2017. That projection has been revised down to 0.7 per cent, following a recession in the fourth quarter of 2016 and the first quarter of this year. Economic growth is expected to recover slowly, reaching 1.9 per cent in 2020.

The weaker growth outlook reflects a continued deterioration in business and consumer confidence that has gathered pace since 2014. It also flows from perceptions of heightened risk as indicated in lower credit ratings, higher bond yields and sluggish investment. In 2016, gross fixed capital investment declined by 3.9 per cent, with large decreases in mining and manufacturing. Capital investment is expected to decline by 0.6 per cent in the current year.

Conditions in the global economy continue to improve, but the risks of financial turbulence remain high, and the longer-term outlook for growth and commodity prices is muted.

These factors are important in the context of South Africa’s external vulnerabilities. The country consumes more than it produces, and relies on foreign savings to finance the gap between low levels of domestic savings and the capital required for its investments. This relationship is expressed in the form of a persistent current account deficit, which is expected to widen over the medium term.

Government debt held by non-residents has risen from 4.4 per cent of GDP in 2007 to 17.6 per cent of GDP in 2017. A sharply negative shift in global investor sentiment towards South Africa could result in large capital outflows, with highly destabilising consequences for the economy.

Fiscal outlook

Over the past five years, government’s efforts to achieve a measured and balanced fiscal consolidation met with some success. While the stabilisation of debt proved elusive, expenditure remained well contained, and the primary balance – the gap between revenue and non-interest spending – narrowed. This progress was sustained by tax revenues that outperformed economic growth.

The National Treasury projects a revenue shortfall of R50.8 billion in 2017/18. Lower revenue this year carries forward, and gross tax revenue is projected to fall short of the 2017 Budget estimates by R69.3 billion in 2018/19 and R89.4 billion in 2019/20.

This reflects slowing economic growth, but may also suggest a profound shift in the relationship between economic growth and tax collection in the years ahead.

Fiscal framework

As a result of revenue shortfalls, the consolidated budget deficit for 2017/18 is expected to be 4.3 per cent of GDP, compared with a 2017 Budget estimate of 3.1 per cent.

The main budget deficit, which determines government’s net borrowing requirement, will be 4.7 per cent of GDP this year.

In contrast to projections set out in the last budget, the revised projection is for the deficit to remain at this elevated level over the medium term. On this estimate, gross national debt is projected to continue rising, reaching over 60 per cent of GDP by 2022.

In this context, government faces difficult choices. To offset revenue shortfalls and reduce borrowing, the contingency reserve has been pared down to R16 billion over the next three years. This leaves government little room to manoeuvre if risks to the expenditure ceiling materialise. Beyond this, it is likely that some programmes will need to be eliminated, or their funding reduced.

South Africa’s stated policy aspirations and its social needs far exceed available public resources. Moreover, there is little space for tax increases in the current environment. Any new policy proposals, or expansion of existing programmes, should address only the most effective and necessary interventions.

Government remains committed to operating within the expenditure ceiling over the medium term. In the current year, however, the recapitalisation of SAA and the South African Post Office put the ceiling at risk of a R3.9 billion breach.

Fiscal risks

In addition, there are several risks to the fiscus over the period ahead:

  • The economy and revenue could underperform projections. The GDP growth outlook may be improving, but the relationship between growth and revenue collection could deteriorate further.
  • Strains and imbalances within the public finances may become more pronounced. The public-sector wage bill has increasingly crowded out other spending and limited government’s ability to increase public employment.
  • Debt-service costs are set to absorb a rising share of revenue.
  • Several years of fiscal restraint have left funding gaps in both infrastructure and social services, reflected in the build-up of unpaid accounts and financial imbalances.
  • Continued financial deterioration of major state-owned companies is a clear and substantial danger to the public finances.
State-owned enterprises

Since 2012, the profitability of state-owned companies has declined due to a combination of operational inefficiencies, governance failures and weak demand.

These factors have increased reliance on borrowing to fund operations, leaving several entities heavily indebted, without sufficient cash to service their debt obligations or even to run their operations.

With no meaningful prospects of a short-term recovery in earnings, lenders are increasingly unwilling to roll over maturing debt or extend new loans, even with government guarantees. State-owned companies that have been able to roll over maturing debt have done so on an increasingly unsustainable basis, with shorter repayment terms, higher interest rates or reliance on government guarantees. Several lenders have declined to roll over debt falling due and required settlement.

Government stepped in to bail out SAA, preventing a call on guarantees or the liquidation of the carrier. It is unlikely that SAPO would have been able to settle its loan without state support given the deficit it has been running for months. Several others, including Denel, South African Express and the South African Broadcasting Corporation face liquidity shortfalls, and will likely require some form of intervention from government.

Pressure on public finances

The public finances face growing strains and risks. Several years of fiscal restraint have left funding gaps in a number of programmes, reflected in the build-up of unpaid accounts and financial imbalances. Without resolute action and planning to cut wasteful and inefficient spending areas, there is a growing danger that the most vulnerable citizens will suffer the effects of fiscal consolidation.

The public-sector wage bill has increasingly crowded out other areas of spending, including complementary inputs that public servants need to do their work. Infrastructure budgets that are poorly designed or not effectively delivered have resulted in high operating deficits, with insufficient allocations for maintenance. Many departments are delaying paying their bills – a trend that contributes to a rising hidden deficit. Provinces entered 2017/18 with R26.4 billion of unpaid bills from the prior year, and a number of municipalities are in financial distress.

This situation requires determined action that balances competing demands and interests. These trade-offs are particularly stark in the current round of public-service wage negotiations. Since 2011, government has been forced to restrict employee headcount growth to accommodate rising salaries.

Yet spending on compensation has continued to grow more quickly than nominal GDP. A fair and reasonable compromise between government and state employees in the current round of wage talks is in the public interest.

The MTEF provides for an overall increase of 7.3 per cent a year to accommodate improvements in conditions of service. Many departments are already at risk of exceeding this limit, even assuming that personnel numbers do not increase. Moderation in public-service personnel costs is essential if improvements in service delivery are to be achieved.

Tax revenue administration

Whilst most of our taxpayers remain responsible, we are noting slippage in compliance. SARS has enforcement powers, which are in the main punitive and this will be applied to taxpayers, who wilfully and cynically avoid paying their taxes. However, SARS also remains sensitive to taxpayers, who are facing challenges.

SARS is also aware of the major problem of illicit financial flows. To this end, SARS is working closely with FIC and SARB to close gaps, which are currently arbitraged. The capacity of these institutions to combat cyber-crime must be enhanced.

From an international perspective, the first exchanges of information under the global Common Reporting Standards took place at the end of September 2017. This information will give SARS insights into South Africans’ foreign financial accounts. Data verification without treaty partners is currently under way.

Country-by-country reporting, which will give SARS insights into risk areas of multi-national enterprises (MNEs), will begin at the end of this year (31 December 2017). The first exchanges will begin next year.

Government is aware of the concerns raised by taxpayers regarding delays in refunds, and with regard to the capacity of SARS to deal with transfer pricing, increasing VAT fraud and aggressive tax structuring.

The Office of the Tax Ombud has also commented on such challenges, and made recommendations.

I am engaging with the Commissioner of SARS on the recommendations made in August by the Tax Ombud, and to take concrete and practical steps to help improve taxpayer confidence.

Twin Peaks reform

The new Twin Peaks system of financial regulation represents a significant reform. It will create a new regulator for market conduct, which will substantially improve the way financial institutions treat their customers. For too long, consumers have been sold inappropriate products, and face high costs and a wall of opaqueness. For example, one of the furniture chains sold retrenchment insurance to retired people.

I will shortly be releasing for public comment, draft transitional regulations to begin the process of implementing the Twin Peaks system. We are on track to create the two new authorities in the 2018/19 financial year.

Supply Chain Management efficiencies, Cost Containment

Since the introduction of expenditure ceilings and the implementation of specific cost containment measures in 2013 spending on consultants, travel, accommodation, catering, advertising and conferences has declined by R2 billion.

The Office of the Chief Procurement Officer (OCPO) has managed to expose corrupt activities in certain government institutions and state-owned enterprises through the review of contracts above R10 million. The fight against corruption is being accelerated and National Treasury is currently working with law enforcement agencies to investigate contracts which are alleged to be irregularly procured in certain state-owned enterprises.

In-year adjustments to spending

The Adjustments Appropriation Bill allows for revisions to the budget tabled in February, as prescribed in the Public Finance Management Act (PFMA) (1999). Major additions to spending include:

  • Allocations for items that were not included in the February budget, but were announced in the budget speech. This includes R4.8 billion allocated to South African Airways (SAA), R3.7 billion to the South African Post Office and a R117 million transfer to the Tirisano Construction Fund Trust, which promotes development projects and black participation in the construction sector.
  • R5.2 billion to defray expenditure authorised by the Minister of Finance in terms of section 16 of the PFMA to forestall a call on government-guaranteed debt by an SAA creditor.
  • R1.5 billion in self-financing expenditure, the bulk of which is for the Department of Home Affairs passport programme.
  • R586 million of expenditure deemed unavoidable, but which was “unforeseeable” when the 2017 Budget was tabled. Of this amount R500 million was allocated to the Department of Water and Sanitation to implement the Butterworth emergency water supply scheme and to upgrade the capacity of the Thukela Goedertrouw transfer scheme. The adjustments budget also proposes to reduce appropriations to national departments by R1.67 billion in anticipation of underspending. In these cases, expenditure trends indicate that the resources will not be used by the end of the year.
Decisive action needed for a new growth trajectory

The National Treasury’s macroeconomic projections imply that per capita income will continue to stagnate in the years ahead. Unless decisive action is taken to chart a new course, the country could remain caught in a cycle of weak growth, mounting government debt, shrinking budgets and rising unemployment. Much depends on the policy choices made and the effectiveness of their implementation. Hard choices are required to return the public finances to a sustainable position. A failure to make such decisions, or to effectively implement them, will reinforce economic and fiscal deterioration.

Government recognises these risks and opportunities, and is acting to break out of the low-growth trap. A new cycle of inclusive development requires clear intervention to stimulate economic activity, ensure effective regulation, improve the competitiveness of manufactured exports, promote localisation and reindustrialise the economy. This in turn requires renewed attention to strengthen the capacity of the state to develop the country’s economic potential.

14-point action plan

In July, the Minister of Finance announced a set of 14 actions agreed to by Cabinet to revive investment. Progress has been made on several fronts:

  • A new board and CEO have been appointed to lead a turnaround at South African Airways (SAA).
  • The Budget Facility for Infrastructure, which is intended to overcome shortcomings in the planning and execution of large infrastructure projects, has begun considering proposals.
  • New procurement regulations have been implemented.
  • The Financial Sector Regulation Act has been signed into law. Work is under way to license broadband spectrum, optimise government’s asset portfolio, reform the governance of state-owned companies and encourage private-sector participation in public investment programmes. A stronger package of measures to stimulate economic growth is being developed.

The public sector will spend more than R300 billion each year on infrastructure, with about half of this funded directly from the budget.

Risks to the outlook

Policy and political uncertainty remain central risks to the domestic economic outlook. Elevated policy and political uncertainty, coupled with weak confidence, discourage investment and consumption. Further risks include a downgrade of the local currency rating and higher administrative prices, which would lead to higher inflation. In contrast, improving commodity prices can benefit mining, especially if policy certainty is restored. Better rainfall, especially in the Western and Northern Cape, can result in stronger-than-expected growth in agriculture.

Alternative scenarios

The National Treasury has generated three alternate scenarios quantifying some of the risks to the baseline economic forecast. Two scenarios involve downgrades to the local currency debt by global

ratings agencies. In both scenarios, the risk premium increases to varying degrees. Global developments leading to broad aversion towards developing-country debt, or a sharp deterioration in the balance sheet of a state-owned company, could have similar effects. A moderate increase in the risk premium could see growth slow to 0.6 per cent in 2018 and 0.9 per cent in 2019. A large increase in the risk premium could see growth contracting by 1.2 per cent in 2018 and 0.8 per cent in 2019. In the third scenario, global growth improves by an annual average of 0.5 percentage points over the medium term. Export commodity prices are 5 per cent higher than the baseline. The risk premium and bond yields are lower. Growth reaches 1.4 per cent in 2018 and 2.4 per cent in 2020.