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Budget 2022: Positive measures need government support for economic growth

In this article, STANLIB’s Chief Economist Kevin Lings discusses positives and negatives in SA’s Budget for the year ahead.
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Kevin Lings

Kevin Lings

Chief Economist

Victor Mphaphuli

Victor Mphaphuli

Head of Fixed Income

Key takeouts 
  • Proceeding with caution. Overall, the Budget was in line with market expectation with a focus on fiscal discipline and few surprises, resulting in little change to the local bond market and currency
  • The revenue windfall over the last year provides relief to current debt levels placing the country in a better fiscal position, however the minister noted this would not be sustainable and is clear that reforms are needed to drive economic growth
  • While tax was not reduced substantially, overall changes were well balanced and positive for the SA consumer
  • On the expenditure side, an allocation of the windfall to ongoing social grants may potentially be more appropriate than allocating to government departments in an attempt to boost the economy
  • The determination to reinstate fiscal discipline was clear

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Budget 2022 puts government in a better fiscal position

Finance Minister Enoch Godongwana made the prudent decision to deploy the R180 billion revenue windfall towards reducing government debt, which will help to allay the concerns of the credit rating agencies. STANLIB’s Chief Economist, Kevin Lings, shares his highlights of the 2022 Budget. Listen below.

Prudent Budget 2022 – what does it mean for economic growth?

The South African currency and bond market showed little reaction to the Budget, suggesting its positive aspects have already been largely priced in. But has Minister Godongwana done enough to please rating agencies? STANLIB Chief Economist, Kevin Lings, discusses the 2022 Budget and its impact on the bond market with Head of Fixed Income, Victor Mphaphuli.

 

Minister of Finance Enoch Godongwana, in South Africa’s 2022 National Budget, demonstrated his commitment to fiscal discipline. Rather than allocating the R180 billion revenue over-collection in 2021/22 to government spending or tax cuts, he decided to apply it to reducing government’s debt. This, says STANLIB Chief Economist Kevin Lings, was the right choice.

 

While the Budget demonstrated commendable fiscal prudence, which will please the ratings agencies, on its own it will not be sufficient to accelerate the country’s growth rate to the levels needed to tackle persistent unemployment and inequality. That growth will depend on government implementation of other key measures.

The South African Minister of Finance, Enoch Godongwana, delivered his first National Budget on Wednesday, 23 February 2022, having been appointed as Minister of Finance in August 2021.

 

SA’s macro-economic environment remains extremely challenging, reflected in declining GDP per capita each year for the past seven years and a record level of unemployment that is considered alarming by global standards. At the same time, world economic growth is expected to slow over the next couple of years. According to the most recent World Bank economic update, global growth is expected to slow from 5.5% in 2021 to 4.1% in 2022 and 3.2% in 2023, as fiscal and monetary support is systematically unwound across the world, given the recent surge in consumer inflation.

 

In January 2022, global inflation rose to 6.1%, its highest level since December 2008, hurt by higher energy prices as well as the impact of global supply disruptions, which were exacerbated by unprecedented monetary and fiscal stimulus, especially from the US. In particular, the US inflation rate recently rose to 7.5%, its highest level since 1982, while in emerging markets inflation has risen to a weighted average of 6.8%.

 

This means that most emerging and developing economies, including SA, are having to curtail fiscal stimulus programmes as well as raise interest rates to contain inflationary pressures, well before the economic recovery from COVID-19 is complete.

 

Unfortunately, the slowdown in global growth over the next couple of years is also likely to coincide with a widening divergence in growth rates between advanced economies and emerging and developing economies. In particular, economic growth in advanced economies is expected to slow from 5% in 2021 to 3.8% in 2022. While this reflects a significant moderation in the rate of expansion, the rate of growth will probably still be sufficient to restore output and investment to their pre-pandemic trend. In contrast, within emerging and developing economies, economic growth is expected to drop from 6.3% in 2021 to 4.6% in 2022. Although 4% is still robust growth, it means that by 2023 output in emerging and developing economies will still be below its pre-pandemic trend, including in SA. The notable exception is China, which has already seen output rise to well above pre-pandemic levels.

South African economy urgently needs higher economic growth

As mentioned above, the South African economy has experienced numerous economic challenges in recent years, which were exacerbated by the COVID-19 crisis. For 2020 as a whole, the South African economy declined by -6.4%, which was the country’s worst annual economic performance, and it is expected to grow by around 4.8% in 2021. Unfortunately, even with growth of 4.8% in 2021, the South African economy is around 3% below the peak level of GDP recorded in the final quarter of 2018. At the same time, total employment remains a staggering 2.1 million below the level of employment prior to the onset of COVID-19 and 2.25 million less than the peak level of employment achieved at the end of 2018.

 

It can be argued that SA’s economic performance surprised on the upside in the first year after the initial COVID-19 restrictions were implemented in Q2 2020, helped by much better export receipts due to higher international commodity prices, as well as by an uplift in retail activity as lockdown restrictions were scaled back. Unfortunately, this positive sentiment all changed with the shock unrest/looting in July 2021, which was compounded by the third and fourth waves of COVID-19 and the return of electricity outages. At the same time, fixed investment activity declined further, damaging an already weak construction sector.

 

Critically, according to National Treasury, SA’s GDP is forecast to grow by only around 2.1% in 2022, slowing to 1.6% in 2023 and 1.7% in 2024. This assumes that the number of new COVID-19 infections remains mostly contained, electricity and water outages are broadly manageable and become less disruptive during 2022, operation Vulindlela gains further momentum, and the current tightening of monetary policy through higher interest rates remains modest. Unfortunately, a growth rate of 1.5% to 2% is still well below the rate required to inspire an increase in private sector fixed investment and widespread job creation.

 

In trying to improve SA’s growth performance over the next few years, one of the key challenges the economy faces is that the traditional policy measures a country would typically use to revitalise economic growth under current circumstances are restricted – especially fiscal and monetary policy. In particular, government cannot afford to cut taxes extensively to boost household consumption and corporate investment, given fiscal constraints. Equally, the government does not have the scope to meaningfully increase its own spending, given its current debt trajectory. This means that government’s growth initiatives need to focus on the implementation of a wide range of private/public infrastructure partnerships. This includes de-regulating economic activity and continuing to make it easier to do business.

 

In the IMF’s recent comprehensive assessment of the South African economy, which was released earlier this month, it highlighted the importance of several critical areas of economic reform that would help improve economic prospects. These include measures to improve the efficiency of the economy, particularly in network industries (rail, port, and road capacity), to reduce the existing regulatory barriers to private investment, increase labour market flexibility to boost job opportunities and intensify actions to address weak governance and corruption. It is hard to argue against the merits of these reforms.

 

The IMF also made a range of valuable suggestions on changes to SA’s fiscal policy framework. These include a focus on fiscal consolidation to reduce public debt, while still protecting the most vulnerable people in society. This consolidation should include, for example, containing public sector wage increases and rationalising transfers to state-owned enterprises (SOEs). The restructuring of Eskom is also regarded as key to ensuring energy security, reducing fiscal risks, and transitioning away from coal-powered energy. Critically, the IMF also flagged the importance of well-targeted social spending to reduce poverty and inequality.

 

While most governments tend to reject external advice on how to improve the functioning of their economy, there is nothing wrong in carefully evaluating well-intentioned advice. The recent deterioration in the government’s debt position, which has been accompanied by a record level of unemployment, regular electricity outages, a fragile water supply, the further deterioration in the provision of public sector health and failing infrastructure in many of the smaller municipalities, is especially damming and makes a strong case for urgent policy reform.

 

Given these circumstances, it is understandable that the Finance Minister presented a National Budget that is primarily intended to restore fiscal discipline, while providing further social support and refraining from adding to the high tax burden currently experienced by many households. It can be argued that SA’s fiscal authorities were ‘gifted’ a very substantial tax revenue out-performance in 2021 (largely as a result of increased mining tax revenue due to higher commodity prices) at a critical time. At the same time, it should also be acknowledged that SA has endured its own share of ‘bad luck’ in the past, especially as a result of an unexpected and sharp deterioration in global economic conditions (for example the global financial market crisis in 2008/2009).

 

Ultimately, the policy choices contained in this year’s National Budget reflect the fact that fiscal policy is currently ineffective in directly revitalising the South African economy. Instead, the success of government’s growth and employment agenda over the next few years will be determined by its ability to make progress in implementing real reforms that encourage the business sector.

The revenue side of the Budget

In 2021/2022, tax revenue massively outperformed budget by an estimated R181.95 billion, implying that total revenue increased by a substantial 23.8% year-on-year. This is SA’s highest level of tax collection, despite the weak economic performance and the fact that employment is still two million below the level prior to COVID-19. The revenue overrun is R62 billion more than the Minister of Finance estimated in the November 2021 MTBPS. While this is an extremely welcome improvement, there is a lot of uncertainty about the sustainability of the current level of tax receipts, especially the surge in corporate tax receipts from the mining sector.

 

As mentioned above, a breakdown of the 2021/22 tax revenue windfall highlights that while the over-collection was broad-based, the biggest surge in revenue was due to corporate taxes (R105.3 billion ahead of the initial budget), followed by individual tax collection (R35.5 billion over budget), VAT (R13.5 billion) and the fuel levy (R6.7 billion). On a negative note, while all tax categories outperformed the 2021 Budget, government paid out R18.7 billion more in VAT refunds in 2021/22, reducing the overall VAT collection performance.

 

The 2021/22 revenue windfall is the largest the country has recorded, largely reversing the revenue shortfall in each of the preceding seven years. This means the fiscal authorities were not forced to seek additional tax revenue through substantial tax hikes. Instead, they were able to provide individuals with relief from the impact of fiscal drag as well as increases to medical tax credits. This should provide individuals with R13.5 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 495 less tax for the year, while a person earning R1 million will pay R4 862 less. While this was expected and the amounts are modest, they are welcome as they help to ease some of the pressure on individuals and provide relief from the damaging impact of inflation.

 

This year’s tax changes are in sharp contrast with prior years. For example, in the 2017/2018 Budget the emphasis was on increasing the top marginal tax rate for individuals from 41% to 45%, whereas in 2018/2019 the decision was taken to increase the VAT rate from 14% to 15%.

 

Fortunately, and very positively, in the 2022/2023 Budget the Minister avoided any surprise tax adjustments. In fact, the only key surprise was government’s decision to leave the general fuel levy on petrol and diesel unchanged. In addition, there was no increase in the Road Accident Fund levy. This is the first time in recent history that fuel levies have not been increased and is a recognition of the difficult economic conditions most households and businesses are experiencing.

 

Other meaningful tax changes in 2022/2023 include further, but unsurprising, increases in the usual array of excise duties, especially on cigarettes and alcohol. After three years of no changes, the health promotion levy will also be increased to 2.31c per gram of sugar. Interestingly, government proposed the introduction of a flat excise duty rate of at least R2.90/ml on both nicotine and non‐nicotine vaping products.

 

In February 2020 the Minister of Finance (Tito Mboweni) announced that government intended to reduce the corporate income tax rate from 28% to 27% to improve investment and competitiveness. Positively, this year’s Budget announced that this would be implemented for tax years ending on or after 31 March 2023. As previously stated, this reduction in company tax is expected to be done on a revenue-neutral basis by reducing the number of tax incentives, expenditure deductions and assessed loss offsets.

 

Overall, the revenue collection estimates for 2021/22 and the medium term seem conservative, not excessive, and largely achievable. There are, however, risks around the tax revenue over the medium term, given the high base from 2021/22 and pedestrian economic growth projections. For 2022/2023 tax revenue is projected to increase by an achievable 3.3% year-on-year, or R51.4 billion.

 

It would have been very tempting for the fiscal authorities to increase a broader range of taxes, including by introducing a new wealth tax, a super-high income tax rate or a further increase in the VAT rate to help mitigate the large fiscal shortfall. However, this year’s Budget highlighted that government is reluctant to increase taxes, given the current weak economic environment and the fact that it would probably have proven to be counterproductive.

 

Consequently, the tax relief for individuals and businesses, as well as the modest number of tax changes, seem largely appropriate in the current economic circumstances. In general, there is a sense that government does not want to increase the already high tax burden on individuals and businesses, especially while the economic recovery remains fragile. Government will, however, continue to investigate the implementation of a wealth tax, but more work needs to be done on the feasibility of any wealth tax, especially the cost associated with administering the tax.

The expenditure side of the Budget

In 2022/2023, government is budgeting to spend R2.157 trillion, a rise of only 3.9%. Over the past five years government expenditure has risen by an annual average of around 8%.

 

The bulk of government spending is still allocated to education at R434.4 billion or 21% of total expenditure, followed by social protection at R369.6 billion (17.9% of expenditure) and healthcare at R253.1 billion (12.2% of expenditure). Unfortunately, one of the fastest-growing areas of government spending remains debt servicing costs, which are projected at 14.6% of total expenditure in 2022/2023.

 

There is still not enough room in the Budget to directly promote job creation, although an additional R18.4 billion is made available for the Presidential Employment Initiative.

 

It is also noticeable that the Minister has provided for only a modest increase in social payments. The money allocated to social development will be spent on the various support programmes in place, with 18.6 million beneficiaries. Treasury has also resolved to implement a new initiative for extended child support grant for double orphans to encourage the care of orphans within families rather than foster care. For the 2022/23 financial year, the grants will be adjusted as follows:

 

  • Old age increases by R90
  • War veterans increases by R90
  • Disability and care dependency grants increase by R90 in April and a further R10 in October.
  • Foster care increases by a once-off R20 in April
  • Child support grant increases by a once-off R20 in April

 

The recently-extended Social Distress Grant has been allocated R44 billion for another 12 months from March 2022. The relief provides R350 to unemployed South Africans and came into effect at the onset of the COVID-19 pandemic.

 

To reduce demand on limited public resources, SOEs 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. 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 SOEs will be informed by the value they create and whether they can be run in a sustainable manner.

 

In 2022/23, National Treasury will publish a framework outlining the criteria for government funding of state-owned companies. The total amount for approved government guarantees is expected to decrease from R601.7 billion in 2021/22 to R552 billion in 2024/25. Eskom currently accounts for almost 55% of these guarantees.

Adjustments to the public sector wage bill

Government’s intention to substantially curtail salary increases over the next three years 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. As a percentage of total spending, it accounted for 35.6% of total consolidated expenditure in 2018/19. In 2019/20, this decreased to 34.5%, and it is expected to decrease further to 30.8% by 2024/25. While the Minister acknowledged the importance of public servants in delivering public services, he underscored the need to curtail compensation spending to increase the allocation of resources to capital expenditure.

 

Given these savings, government estimates that compensation at the consolidated budget level will grow by 2.6% in 2022/23 and there will be average growth of 1.4% per year over the medium term. The savings will be achieved by doing away with the annual cost-of-living adjustment in the public service until 2023/24, together with measures to reduce headcounts through a combination of early retirement and natural attrition, as well as freezing or abolishing non-critical posts.

 

Even by international standards, SA’s wage cost is exceptionally high, at around 14.8% of GDP, which is about five percentage points higher than the Organisation for Economic Co-operation and Development average, and in line with Iceland and Denmark. Regrettably, government’s aim to limit the growth in salaries will act as a restriction on economic activity, as those salaries are necessary to support household consumption. Government needs to inject stimulus elsewhere to offset this effect and ensure that economic activity is not negatively affected by these austerity measures.

 

While the Minister has clearly outlined government’s intention to control salary expenses, it is unclear  whether this plan can be achieved. The scheduled wage increase of two years ago remains in dispute and is awaiting a decision by the Constitutional Court. In addition, a new round of collective bargaining will begin in March 2022. If government fails to keep the compensation baseline within affordable limits, it is possible that the Minister might be forced to revise up his salary budget when he presents the MTBPS in October 2022.

Debt servicing costs continue to rise at a very rapid pace

As mentioned earlier, SA’s public sector debt and debt servicing costs have escalated dramatically in recent years. In particular, government debt jumped from 57.4% of GDP in 2019/202 to 70.7% 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 SA’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, health care, and housing development.

 

Very encouragingly, the better-than-expected revenue outcome, 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 75.1% of GDP in 2024/2025, which is significantly down from the October 2020 estimate of around 95%. At the same time, debt servicing costs are projected to rise modestly to just over 20% of tax revenue over the next three years. Clearly, however, significant risks remain to this projection, including a larger-than-expected increase in salary costs, tax revenue shortfalls, sustained weak economic growth, the introduction of a substantial Basic Income Grant (BIG) and further funding requirements from the major SOEs.

 

SA’s credit rating

Given the country’s sharp fiscal deterioration in recent years, Moody’s, Standard and Poor’s (S&P) and Fitch all downgraded SA’s international credit rating to below investment grade. For example, in November 2020, Moody’s downgraded the credit rating from Ba1 to Ba2 and maintained a negative outlook on it. Fitch also downgraded the credit rating from BB to BB- but has subsequently revised the outlook from negative to stable. S&P has kept SA’s credit rating unchanged at BB- for some time. This means that S&P and Fitch have SA on the same credit rating, while Moody’s is effectively one notch higher – but all SA’s international credit ratings are below investment grade.

 

More positively, the 2022/2023 National Budget will help to mitigate some of the concerns that credit rating agencies have highlighted in recent years. However, they will probably adopt a “wait-and-see” approach to credit rating upgrades. In particular, they will evaluate government’s ability to implement some of the critical fiscal consolidation initiatives outlined in the Budget, while lifting economic growth.

 

Unfortunately, while the government has identified several key policy initiatives that could help to re-invigorate the economy (such as infrastructural development) there is still not enough evidence of implementation. Unsurprisingly, the implementation of sound economic policies builds confidence, but the opposite is also true. If SA can make progress in lifting economic growth and reinstating its fiscal credibility, international credit ratings should slowly start to improve.

Conclusion

The 2022 National Budget was presented under difficult economic conditions, although the tax revenue windfall made the Minister’s job significantly easier. It is encouraging that the Minister did not attempt to deliver a politically expedient Budget, given the ANC elective conference at the end of this year, nor were there any shock tax announcements. Instead, the Minister reiterated the need to control expenditure over the medium term, while continuing the path of fiscal consolidation. The success of this year’s Budget will be determined by government’s ability to maintain fiscal discipline, while ensuring that key policy initiatives are implemented far more effectively.

 

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 has 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, the most viable policy initiatives 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, bold initiatives that make it easier and safer for foreign tourists to visit SA, the urgent clarification of key policy pronouncements, a demonstratable focus on restoring good governance, and the urgent reorganisation of the energy and water sectors.

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