1. Post-pandemic nominal growth expectations
The loss in momentum behind growth to 1.2% in the past decade from 3.5% in the previous decade reflects chronic policy uncertainty, stretched government finances, infrastructure constraints and dwindling confidence.
Sentiment remains in the doldrums
The growth contribution from fixed investment to overall GDP has waned during the past 10 years, slipping from 19.5% a decade ago to 17.2% in the second quarter of 2020.
A reluctance to invest in the SA economy, given concerns about insufficient levels of demand and uncertainty about the political climate, has left growth in private fixed investment at a paltry rate of 0.4% on average for the past 10 years relative to 7.2% in the previous 10-year period (which had included a construction works-related investment boom in the run-up to the 2010 FIFA World Cup).
Considering that it typically takes fixed investment spend longer than overall GDP to recover to pre-crisis levels (see chart below), we cannot rely on growth in fixed investment alone to yank the economy out of its growth slump.
Incremental progress on the implementation of economic and regulatory reforms should see local sentiment levels edge higher from a gloomy base in the coming years, but no quick turnaround is projected in our view until the crisis in confidence can be adequately addressed.
Protracted recovery to pre-crisis levels
Heightened consumer and business stress in SA has been exacerbated by the seventh most stringent lockdown restrictions in the world and this should keep a lid on growth prospects in the medium term.
Moreover, export growth is unlikely to strengthen significantly given that the wind has been taken out of the sails of globalisation by unfavourable trade developments between the United States and China (even prior to the pandemic) and the souring of the global attitude towards trade interlinkages, thanks to the pandemic and the associated lockdowns which accentuated supply chain dependencies.
We expect real growth in GDP to average negative 0.8% between 2020 and 2023 in comparison to National Treasury’s June 2020 forecast of negative 0.4%, but these figures are likely to be adjusted lower by Treasury in the upcoming October medium-term budget, following the high-frequency data releases published since then.
Risks to our growth view remain firmly to the downside. Estimates by the Council for Scientific and Industrial Research point to a low energy availability factor well into 2022, indicating a high risk of load shedding.
Diminished demand-pull inflation pressure and a muted pass-through from past depreciation in the local currency should see headline inflation averaging 4.3% between 2020 and 2023.
This estimate is higher than Treasury’s October 2019 estimate of 3.9% for the corresponding period, but only a tad higher than its expectation for GDP inflation in the same period.
We are broadly in line with Treasury’s forecasts using these real GDP growth and inflation forecasts to proxy the outcome of the nominal GDP deflator.
In our opinion, the depressed growth environment necessitates a considerable focus on expenditure cuts in non-critical areas of the budget.
It also requires a shrinking of tax evasion and fraud as well as a recovery in tax morality on the revenue side.
2. Tax collection in a fragile growth environment
The standstill in economic activity, triggered by the lockdown restrictions, had a detrimental effect on government revenue, which has disappointed on a fiscal year to date (YTD) basis relative to the average for the past five years (see chart below). Meanwhile, expenditure trends were only slightly weaker as government embarked on a countercyclical fiscal approach to prop up economic growth through government spending.
Growth in government revenue and expenditure compared to past averages
At a YTD growth rate of negative 20.6%, total tax revenue is lagging the past five-year average of 1.2% but is only marginally lower than the negative 18.3% projected by Treasury in the June 2020 Supplementary Budget.
Meanwhile total government expenditure is growing at a YTD average of 4.2% in comparison to the past five-year average of 7.4% and government’s June 2020 estimate of 7%.
SA had the sixth largest fiscal stimulus response to the pandemic from its emerging market (EM) peer group (see chart below) and second largest monetary stimulus (in the way of policy rate cuts), but the country still suffered the third worst contraction in growth in the second quarter of the year in comparison to the peer group.
This is suggestive of reduced effectiveness of the country’s stimulus response.
In its Monetary Policy Review for October, the SA Reserve Bank (Sarb) highlighted low and falling fiscal multipliers (change in GDP from a change in government expenditure).
“If government spending is paid for with higher taxes, multipliers will tend to be low. Funding through debt can support a higher multiplier where debt is perceived as sustainable. Where sustainability is in doubt, more debt will tend to reduce capital inflows, raise interest rates for the entire economy, and undermine confidence in the economic outlook, thereby lowering the multiplier.”
Falling fiscal multiplier
The underperformance in revenue has been largely broad-based (see first chart below), however momentum appears to be recovering in corporate income tax (CIT) and value-added taxes (Vat); see second chart below.
According to the South African Revenue Service (Sars), the hardest hit sectors contributing to CIT included finance and manufacturing, which were negatively affected by load shedding, depressed confidence and heightened uncertainty.
On the other hand, personal income tax (PIT) collections continue to struggle against the backdrop of accelerated job losses and deep pay cuts.
Growth in government revenue compared to past averages
Decline in growth in Vat collections showing signs of bottoming out
PIT reached 10% of GDP in fiscal year (FY) 2018/19, reaching levels last seen in FY1998/99 (see chart below). This is in spite of country-wide wage trends having dipped.
Personal income tax share nearly back at 1999 peak
Moreover, despite an increase in the number of registered taxpayers to 21.1 million in FY2017/18, the number of assessed taxpayers has dropped to 4.9 million, highlighting a narrowing in the tax base (see chart below).
According to Sars Commissioner Edward Kiestwetter and BusinessTech, Sars tax direct directives for retrenchments in FY2019/20 had totalled 287 000 from 239 000 in FY2018/19. This points to fewer pay-as-you-earn contributors and more broadly signals a further erosion of the tax base.
An eroding tax base
Given the poor state of the economy and SA’s already high tax burden (see chart below), it is unlikely that government will hint at any new tax hikes above what was already announced in the June 2020 Supplementary Budget (R5 billion in FY 2021/22, R10 billion in FY22/23 and R15 billion in FY23/24), in our view.
Tax-to-GDP ratio close to peak
Treasury will likely give us an update on its expectations for the tax buoyancy ratio which is currently tracking above one (i.e. indicating slightly more tax revenue per unit of GDP), unlike the average observed since the global financial crisis (see chart below).
In July, Treasury noted it was considering the recommendations of the Davis Tax Committee (DTC) for a wealth tax, particularly with its links to estate duties and land taxes.
We do not see this as a significant source of revenue, but it may be used, in our opinion, to pave the way for more broad-based taxes to fund rising social needs.
Tax buoyancy ratio
An additional once-off source of revenue may result from the auctioning of high-demand spectrum. The spectrum auction which was originally scheduled for December 2020 has been pushed out to March 2021 due to outstanding matters related to the viability of the Wireless Open Access Network. TechCentral projects government could raise around R12 billion through the auction. This is only likely to be recognised in FY2021/22.
3. Developments in the ongoing public sector wage dispute
The Organisation for Economic Co-operation and Development (OECD) has suggested that SA’s wage bill, at 12% of GDP, is one of the highest among OECD partner countries (see chart below).
An exorbitant average increase of 11% per year for the past decade has seen government wages grow to 38% of consolidated government spending in 2019.
According to the OECD, the number of employees only increased by 100 000 in the past decade, leaving wage increases as the main culprit behind the burgeoning wage bill in SA. Public employment as a share of total employment in SA ranked relatively close to the OECD average in 2017.
Outsized government wage bill
Promotion policies have also been to blame. In FY2006/07, 10% of the public sector workforce were employed in the higher job grades (level nine to 16), but by 2017, this share had grown to 21%.
The OECD showed that top managers in SA’s civil service earn an average revenue of nine times the per capita GDP, which is far higher than the six times recorded for the OECD average.
Government has not paid workers their increase in salary for the current fiscal year (between 4.3% and 5.4% depending on their employment level and take-home pay) that had been previously negotiated in the multi-year wage agreement commencing in 2018.
These increases would cost government R37.8 billion and can no longer be afforded due to the effect of Covid-19 on government’s finances. Government more ambitiously aims to reduce the public sector wage bill for the next three years by R160 billion.
It is unlikely that an agreement will be reached in time in our view to change the wage bill estimates that were presented in the June 2020 Supplementary Budget. Nevertheless, efforts to stick to its proposed cuts will elevate Treasury’s credibility in our opinion.
Although this would be a significant step towards fiscal consolidation, we acknowledge the negative effect it would have on household disposable income and as such do not see a significant recovery in household spend in the near term, particularly as growth in jobs remains weak and as banks maintain a cautious stance on lending.
4. Ability to supplement pro-poor spending
Government has maintained a redistributive policy stance despite slowing revenues and tighter fiscal space. More than two thirds (68%) of government expenditure is allocated to education, health, social grants, basic services and other social objectives.
In comparison to OECD countries, SA’s social programme is one of the largest in relation to GDP (see chart below).
Government policy is highly redistributive
In response to the Covid-19 crisis, government extended social assistance by:
- Topping up all social grants between R250 and R300 for six months (child support recipients received an additional R500) between May and October 2020;
- Introducing a temporary caregiver grant of R500 a month between May and October 2020;
- Introducing a Social Relief of Distress grant of R350 a month between May and October 2020; and
- Disseminating a million food parcels
With the lockdown restrictions negatively affecting numerous households, calls for a basic income grant have been revived.
The OECD pointed out that cash transfers (handed out to more than 18 million in SA) contribute more than 70% of the income for the poorest 20% of SA’s population. The OECD believes the redistributive nature of these cash transfers has helped to alleviate poverty and has reduced the share of the population with 60% or less than the median disposable income from 45% to 32%.
Human rights group Black Sash has argued for a phased-in approach for basic income support, first prioritising those in the age groups between 18 and 24 and those between 50 and 59. According to BusinessTech, a discussion paper by the ruling party calculated a monthly grant of R500, for those aged 19 to 59 who are not eligible for any other aid, would cost the state R197.8 billion a year. The paper proposed 50% to 60% could be recouped through additional taxes on the employed.
Near-term pressure on SA’s tax base, arising from retrenchments, lower bonus payments and reduced wage increases, suggest these additional taxes will be difficult to implement at the February 2021 National Budget, but increasing support for a basic income grant suggests further discussions will be held in this regard, particularly as government has not released an official stance on this as yet.
5. Drawing the line on SOE funding
State-owned enterprises (SOEs) play a crucial role in SA’s economy. The OECD found that SA has one of the highest public ownership of firms (see chart further on) and this influences the competitiveness of intermediate goods.
Given the operational and financial underperformance of many of these public entities, this has had a negative consequence for the cost of doing business in SA.
The Covid-19 pandemic has in addition led to a number of finance-constrained SOEs requesting further aid from government. They include:
- R9 billion for the SA Post Office;
- R5 billion for the SA Broadcasting Corporation;
- R5 billion for Airports Company SA;
- An undisclosed amount for Denel to pay salaries and complete projects for the SA National Defence Force after the entity recorded a loss of R1.7 billion; and
- An additional R10.5 billion for the rescue plan of South African Airways (its 2019 financials reflected a loss of R5 billion) for the airline to resume operations.
At last reporting, Eskom had projected a R20 billion loss for financial year 2020. Even after receiving R133 billion in government support since 2008 (and expected to receive R112 billion in the next three years), the pwoer utility’s debt burden sits at R454 billion.
In the Letter of Intent drafted to the International Monetary Fund in lieu of the Rapid Financing Instrument facility, Treasury and the Sarb suggested transfers to SOEs would be rationalised and these SOEs would in turn have to meet key performance indicators.
SOEs’ grasp on the economy is high
With explicit guarantees adding around 8% to the debt-to-GDP ratio (total contingent liabilities added about 19% of GDP in FY2019/20), any additional guarantees or cash injections would add further strain to government’s balance sheet.
Sanisha Packirisamy is an economist and Herman van Papendorp head of investment research and asset allocation at Momentum Investments.
Republished with permission from Moneyweb