‘SA may sidestep junk status’

There is a plausible case that South Africa is not a junk status country and it may buy some time to avert a sovereign rating downgrade, the head of the Davis Tax Committee has argued.

“The question is: what do we do with that time?” Judge Dennis Davis asked at a panel discussion hosted by Investec Asset Management.

S&P Global Ratings and Moody’s are due to announce their decisions on South Africa’s sovereign credit rating in the next three weeks. S&P has South Africa on the lowest investment grade rating – one notch above junk.

Davis, who previously said a downgrade would be a disaster, expressed his irritation with ratings agencies and said he didn’t understand why South Africa had to be held captive by a “bunch of bureaucrats” with limited knowledge of the country, but said the South African economy could grow by 1.2% next year. Although this was still fairly muted, growth moving “north rather than south” was a positive development.

The tax revenue and expenditure numbers reported during the Medium-Term Budget Policy Statement (MTBPS) were verifiable and achievable while limiting damage to the economy, he said.

Finance Minister Pravin Gordhan announced he would probably need to raise tax revenue by R28 billion next year, while lowering the expenditure ceiling by R26 billion in the medium term.

Davis said despite various challenges, the South African economy could grow at 3% per annum if it could get its institutional structures, governance and policy certainty in line.

Each percentage point of GDP growth could add in excess of R5 billion or R6 billion to tax revenues. It is therefore crucial to get the economy going, he added.

Both locally and internationally investors are sitting on large piles of money that they are not investing due to anxiety and uncertainty, he added.

Nazmeera Moola, co-head of fixed income at Investec Asset Management, said some political certainty would have huge benefits. Corporates are pouring cash into the money market instead of investing.

It is only the third time since 1994 that the year-on-year growth rate in private sector fixed investment has turned negative. The previous times were during the 1998 Asian crisis and the 2008 global financial crisis.

“This is the first time since 1994 that private sector fixed investment is contracting without a global crisis,” she said.

In June, S&P Global Ratings indicated that there were three circumstances under which it would downgrade South Africa’s rating to junk – if growth didn’t improve, if net general government debt and government guarantees to state-owned enterprises surpassed 60% of GDP or if there was an erosion of institutional strength.

Moola said growth has improved slightly. Debt hasn’t surpassed the 60% level (a nuclear deal would probably have to be signed for that to happen) and since June there has been evidence of strength of some of the country’s institutions, particularly the courts.

“It has been noisy, it has been traumatic at times, but it hasn’t been weaker institutions,” she said.

Rating agencies would have to acknowledge that South Africa’s judiciary passed the strength test with “more than flying colours”, Davis argued.

Davis said despite a huge amount of pressure on the judiciary, and judges being called “counter revolutionaries”, the judiciary has held firm to the constitutional ambitions.

“My concern is we cannot expect the judiciary to shoulder the burden of democracy alone.”

Civil society, political parties and the business community were equally responsible, he said.

Tax collection and expenditure

Gordhan was under pressure to stick to the fiscal targets set in the MTBPS.

Davis said South Africa’s consumption expenditure was too high. The country has a bloated public service and gave away a carefully constructed reserve meant to cushion it against exigencies during the 2015 cycle, “because of the ridiculous [wage] increase in the public service sector”.

But the real question was how government was spending the money – while consumption expenditure could be dangerous, capital expenditure could help the economy to grow.

The chief procurement officer at National Treasury previously said around R250 billion of the roughly R600 billion government spent on goods and services every year was tainted. This meant the price was too high because of corruption, ineptitude, inefficiency or a lack of experience, Davis said.

The price paid was between 20% and 30% too high.

“That means that we are talking about between R50 [billion] to R75 billion we are wasting. So there are a whole lot of things that we have to do on the expenditure side.”

Asked how the minister was likely to get the additional tax revenues announced in the MTBPS, Davis said getting the R28 billion was possible without massive increases.

Due to political and economic reasons, a VAT increase is unlikely.

Unions vehemently oppose a VAT increase and World Bank figures suggest that a one percentage point increase in the VAT rate could depress GDP growth by between 0.3% and 0.4% in the short term while increasing inflation by a similar number.

A corporate tax hike is also a no-go as it would deter investment and make South Africa less competitive.

Although it wouldn’t generate significant amounts of revenue, Davis said one option is to increase personal income tax rates for wealthy individuals. Raising the marginal rate from 41% to 45% for people earning around R1.2 million to R1.5 million a year would raise about R5 billion to R6 billion. If only low-income individuals are compensated for fiscal drag, government could probably get between R8 billion and R10 billion from the personal income tax side.

Addressing base erosion and profit shifting (BEPS) could probably raise “quite a few billion” as well, while government could get at least R10 billion from the special voluntary disclosure programme if it played its cards right, he argued.

It might also have to increase the skills development levy by 1 percentage point to fund tertiary education.

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