October 31, 2019
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Kevin joined then-Liberty Asset Management as an economic analyst in 2001. As STANLIB’s Chief Economist, he is responsible for domestic and global economic research and forecasts. Kevin also provides input into STANLIB’s asset allocation processes and provides relevant economic research for our Fixed Income, Property and Equity teams.
The National Treasury faces a number of challenges as we head towards the end of 2019.
A current shortfall in tax revenue in South Africa means that government needs to be addressing tax collection. Government should also be willing to significantly curtail expenditure over the next three years given the recent surge in public sector debt as well as the looming increase in the fiscal deficit.
Our Minister of Finance also needs to clarify some key policy issues.
For example, to what extent will government be looking to implement National Treasury’s recently released policy document, how much will the introduction of National Health Insurance (NHI) cost the state and how will the NHI be funded? Other key focus areas include government’s willingness to reallocate funds away from consumption expenditure into infrastructural investment, as well as government’s ability to further improve the efficiency of spending through the reduction of “irregular, fruitless and wasteful” expenditure.
The inefficiency of government spending together with the ongoing lack of policy certainty has clearly undermined private sector investment, leading to lacklustre economic growth and employment.
The South African government’s fiscal position has deteriorated substantially in the last decade and remains under significant pressure. These pressures can be divided into three main constraints.
Tax revenue behind budget
First, tax revenue is well behind budget. Data from the National Treasury’s monthly statement of revenue, expenditure and borrowing indicates that in the first five months of the financial year, the state of government finances remains weak. South Africa’s fiscal deficit year-to-date amounted to R189.4 billion, compared to R131.4 billion during the same period last year. The higher deficit stems mostly from the gross tax revenue side.
According to the February 2019 National Budget, government expects to collect R1.42 trillion in gross tax revenues in 2019/20, which is an overly optimistic growth of around 10%. This increase is expected to be driven by a double-digit increase in personal income tax and VAT.
Since the beginning of the financial year, gross tax revenue has been coming in below the budgeted growth estimate. At this stage of the fiscal year, government should have collected around 41% of the budget estimate in order to keep up with the required growth rate. So far, however, government has collected only around 36% of budget.
Based on current trends, the government’s tax revenue shortfall is estimated at around R60 billion to R65 billion in
2019/2020, with evidence of weakness across most areas of tax collection – although a lot can change, both positively and negatively, over the coming months. It is clear that without a sustained increase in economic growth accompanied by an increase in employment, as well as an improvement in revenue collection and tax morality, the South African government is going to continue to struggle to meet its revenue targets, right through to 2022. In each of the past five years, tax revenue has meaningfully underperformed budget. Without higher economic growth, tax collection will continue to dwindle.
Guarantees for state-owned enterprises
The second constraint is that the government has had to provide many of the state-owned enterprises (SOEs) with significant additional finance. The value of government guarantees to SOEs amounted to R372.4 billion at the end of the 2018/2019 fiscal year, which represents an increase of 15.9% compared with the previous year and is up 28.2% compared with 2016/2017.
These guarantees remain a major concern for National Treasury as well as the international credit rating agencies.
Furthermore, government is under pressure to provide further financial support to many of the SOEs, which limits its ability to implement meaningful fiscal consolidation. For example, in the February 2019 National Budget the Minister of Finance indicated that government would transfer an additional R23 billion to Eskom each year for the next 10 years to support its balance sheet. Shortly after the National Budget was released, the authorities acknowledged that Eskom would require much more than R23 billion in 2019/2020. Consequently, government decided to allocate an additional R26 billion to Eskom in 2019 and a further R33 billion in 2020. It also indicated that plans to restructure/unbundle Eskom would be announced before the end of 2019. We are still awaiting these details.
Clearly there is a real risk that the SOEs will require additional funding in the years ahead. The good news is that government is looking to implement a series of structural reforms at the various SOEs. According to National Treasury, these reforms will adjust business models in response to changed economic conditions, restore good governance, bolster operational efficiency, and strengthen financial controls and planning. Hopefully, these reforms can be implemented effectively and without placing further strain on already-fragile government finances. It is critical that National Treasury is able to stop the damage that SOEs have inflicted on the government’s fiscal position and systematically improve their balance sheet.
Based on current trends, the government’s tax revenue shortfall is estimated at around R60 billion to R65 billion in 2019/2020.
Inefficient government spending
The third constraint is the need for fiscal discipline, especially an improvement in the efficiency of government spending. A few years ago, National Treasury introduced an Expenditure Ceiling, attempting to control government spending and restore fiscal discipline over the medium term. In general, the results of this initiative have been encouraging. For example, in the 2017 budget review, government set its expenditure ceiling at R1.323 trillion for 2018/2019. In the 2017 Medium-Term Budget Policy Statement (MTBPS) this ceiling was lowered to R1.316 trillion, then dropped to R1.315 trillion in the 2018 budget review, R1.314 trillion in the 2018 MTBPS and finally in the 2019 budget review expenditure for 2018/2019 was recorded at R1.310 trillion. Similarly, in the current fiscal year (2019/2020) government expenditure is running well behind budget.
Unfortunately, while there has been an attempt to restore fiscal discipline, the split between consumption and capital expenditure remains problematic. Over the past 10 years, government has tended to increase consumption expenditure at the expense of capital projects. This clearly undermines economic growth over the longer term and is leading to the deterioration of many vital areas of service delivery, including water, healthcare and education. Furthermore, the efficiency of spending has deteriorated significantly, with the Auditor General reporting a significant increase in wasteful and unauthorised expenditure in recent years. This, coupled with high levels of corruption, undermines the effectiveness of government services, negatively impacting confidence. Lastly, government has raised expectations regarding the implementation of several ambitious projects, for example National Health Insurance.
Achieving these ambitious goals is going to become increasingly problematic unless there is a substantial increase in tax revenue, and an improvement in the efficiency of government expenditure. As a result of these constraints, government debt has risen from a low of 26% of GDP in 2009 (at the time Moody’s had assigned South Africa an ‘A’ credit rating), to an estimated 58.5% of GDP in 2019/2020 and it is expected to rise to well over 60% of GDP within the next three years. In value terms, this means that since 2009 government debt has increased by more than R2.5 trillion, equating to an average annual increase of a staggering 16%. This is especially damning when you consider what has been achieved with this increased debt – sustained low economic growth, record high unemployment, a record low savings rate, systematic downward revisions to the credit rating, regular electricity outages, a fragile water supply, the deterioration in public sector health, and poor education outcomes.
The situation is made worse by the fact that this debt excludes all of the SOE debt, which equates to over 10% of GDP. (Eskom’s total debt represents between 8.5% and 9% of South Africa’s GDP).
Fortunately, only around 12% of South Africa’s government debt is in foreign currency, which is especially low by international standards. This substantially reduces the risk of default, especially if the currency were to weaken significantly. Nevertheless, foreign investors own 37% of the government’s debt through the South African bond market, which highlights that government’s financial position is still vulnerable to changes in foreign investor sentiment towards the country. In the past 18 months foreign holdings of SA government bonds have systematically decreased from a high of 42.8% of total government debt as recently as March 2018, highlighting the loss in foreign investor confidence in South Africa.
While it may have been unrealistic to expect the Medium-Term Budget Speech to deal with all of these challenges, it is critical that government starts to urgently relieve these fiscal constraints, before the government’s funding requirement and debt level become unbearable within South Africa’s fragile economic system.
- The South African government’s fiscal position has deteriorated substantially.
- Tax revenue is well behind budget.
- The value of government guarantees to SOEs amounted to R372.4 billion at the end of the 2018/2019 fiscal year.
- In the current fiscal year (2019/2020) government expenditure is running well behind budget.
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