Budget 2023 – Minister of Finance strikes a balance between generosity and prudence

SA’s National Budget recognises the need to help households and Eskom while maintaining fiscal discipline.

Kevin Lings

Chief Economist

Victor Mphaphuli

Head of Fixed Income

Key takeouts

A sensible budget as the Minister of Finance strikes a balance between generosity and prudence.
It delivered much-needed proposals to address load shedding and give relief to hard-pressed consumers, businesses and Eskom, while showing commitment to preserving a primary budget surplus.
It achieves a level of fiscal discipline that will satisfy investors and credit rating agencies but efficient revenue collection will remain key.
South African bond yields and the currency responded positively to the 2023 National Budget.

Listen to our podcasts below

A Budget that strikes the right balance

SA’s 2023 National Budget tackles a number of concerns.

In this podcast, STANLIB’s Chief Economist, Kevin Lings, discusses how the 2023 National Budget released on Wednesday manages to balance demands for energy and social support with fiscal prudence. To hear more, click on the below.

Budget 2023 pleases markets, but risks remain

Markets and the currency responded positively to SA’s 2023 Budget proposals.

In this podcast, STANLIB’s Chief Economist, Kevin Lings, and Head of Fixed Income, Victor Mphaphuli, discuss the market’s response to the 2023 National Budget and what risks remain. To hear more, click on the below.

South African National Budget 2023/2024 – a brief review

The South African Minister of Finance, Enoch Godongwana, delivered his second National Budget on Wednesday, 22 February 2023. He was appointed as Minister of Finance in August 2021.

SA’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 (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 and avoid any further credit rating downgrades.

SA 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 infrastructural capacity – including rail and port. The negative impact of electricity outages, combined with key infrastructural breakdowns, is reflected in the performance of the 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 SA’s retail spending has fallen by -2.5% in real terms. It 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, SA’s economic activity will struggle to gain momentum, limiting the growth of the 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% 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 debt is at a comfortable and sustainable level.

Impressively, he also highlighted that government expects to be able to achieve a primary budget surplus (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 its intention to adhere to fiscal discipline. A primary surplus will go a long way towards convincing the public, investors, and credit rating agencies that government is serious about maintaining 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 unable to meet the target, largely because of weak economic growth and an inability to rein in government expenditure, especially consumption spending and salary expenses. Hopefully this time it will be different.

Investors need to be mindful of two risks. The first is that government’s revenue projection appears to be ambitious in a low growth environment. 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.

Finally, the Minister of Finance is forecasting that SA’s GDP will grow 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 its budgeted level of fiscal consolidation. Given the current balance sheet constraints within central government, as well as the 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 outperformed budget by an estimate R93.7 billion, implying that total revenue increased by a substantial 8.2% year-on-year. This follows an outperformance 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 collection was driven by strong tax collections from the mining sector amid elevated commodity prices. Importantly, the finance 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 about 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.

Arguably, 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 are 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, he 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 provide 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 provided 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 two years for all renewable energy projects, with no thresholds on generation capacity. In addition, 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 the 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.

These are welcome incentives, and a better-than-expected outcome, especially for businesses, given that the incentive has no limit and can be claimed over two years. Unfortunately, the benefit for individuals is less emphatic as it mostly targets those who can afford to install solar panels 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% over 2022/2023. While this appears largely achievable, as it only implies a tax buoyancy of 1.06, there are significant risks to government’s tax collection projections over the medium term. 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

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 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. In 2018/2019 this accounted for a substantial 35.6% of total consolidated expenditure, but it 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 delivery 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, SA’s wage cost remains exceptionally high by international standards. While the Minister has clearly outlined government’s intention to control salary expenses, it is unclear 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 in the Budget. Growth in the wage bill is projected to average 3.3% over the medium term, well below the 4.9% average inflation rate for the period, representing one of the biggest risks to National Treasury’s expenditure projections.

Eskom Debt Relief Arrangements

In 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 three years, the government has committed to provide Eskom with debt relief of R254 billion: R168 billion in capital payments and R86 billion 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 three 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 three years. In addition, government will directly take over up to R70 billion of Eskom’s loan portfolio in 2025/26.

To receive this bail-out, Eskom will need to adhere to a range of strict conditions, including being forbidden from taking on new debt during the 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, National Treasury is considering proposals to address the R56.3 billion in 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 for 2022/23 to assist its 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.

Apart from Eskom, no restructuring of other SOEs was 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, SA’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 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, 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, 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 uncomfortably high, the deterioration is being contained, with government debt projected to fall to around 65% of GDP by 2030/31.

Conclusion

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. It is encouraging that the Minister did not attempt to deliver an outright politically expedient Budget, given the National Election in 2024, 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 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 it retains 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 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, apart from trying to resolve the ongoing electricity crisis, 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, a turnaround strategy for failing municipalities, a demonstrable focus on restoring good governance (including successful prosecutions), and the urgent reorganisation of SA’s fragile rail and port capacity.

STANLIB Economics Team

February 2023

Economics & Markets