Boosting economic growth is the only option left but will the politics get out of the way?

COVID-19 SERIES 4 – 2020/21 supplementary budget

Boosting economic growth is the only option left but will the politics get out of the way?

Highlights

National Treasury forecasts economic growth of -7.2% (in line with SARB’s -7.1%) and slightly worse than our April forecast of -6.1%.
The contraction in growth leaves a tax shortfall of R304bn (inclusive of R26bn) tax relief compared to the February budget.
New revenue measures are at the margin and only come in 2021/22 and 2022/23 at R5bn and R10bn respectively.
Expenditure rises by R145bn (inclusive of Land Bank recapitalisation) compared with the February budget, largely related to COVID-19 spending.
Consolidated budget deficit rises to 15.7% of GDP while the main budget deficit is at 14.2% from 6.8% and moderating to 7.7% by 2022/23.
The debt path rises to 82% of GDP this fiscal year and explodes above 100% in 2024 if no action is taken to cut spending and grow the economy.
A primary surplus in 2023/24 is pencilled in through R230bn expenditure cuts in 2021/22 and 2022/23 (in addition to R160bn public sector wage savings pencilled in the February budget) and further cuts thereafter.
Zero-based budgeting (ZBB) will be introduced from October onwards to cut waste.
All considered, the medium-term outlook is too ambitious, as it relies on spending cuts instead of higher economic growth and has execution risks.

South Africa’s macroeconomic environment has significantly deteriorated to its worst performance in history

Economic conditions have significantly worsened since the February budget, with the International Monetary Fund releasing its mid-year economic outlook updated for global economic growth, where it expects conditions to deteriorate compared to its April world economic outlook. The global lender now expects global growth to contract by 4.9% (compared to -3.1% previously) before rising to 5.4% in 2021. In line with weak global expectations, National Treasury forecast economic growth to contract by 7.2% in line with the South African Reserve Bank forecast of -7.1% – much worse that its February forecast of 0.8% in 2020 from 0.2% in 2019. Both Treasury and SARB forecasts are just over a percentage point worse than our April forecast of -6.4%.

The contraction in economic growth will come with company bankruptcies and job losses. Indeed, Statistics South Africa reported this week that the unemployment rate has increased to 30.1% at the end of March 2020 from 29.1% at the end of 2019. This was pre-COVID-19 impact, which implies that when the impact of the pandemic is reflected, the unemployment rate will rise further and result in income loss. Even for those employees who will not lose jobs, their salaries and wages could have been reduced as companies try to save costs. The impact of lower spending power combined with lower petrol prices and a dent in consumer confidence result in a decline in demand pull inflation, which the Treasury forecast at 3.0% in 2020 before rising to 3.9% in 2021. These forecasts are slightly below the SARB’s forecast of 3.4% and 4.4% in 2020 and 2021.

All major tax revenue sources to undercollect

There is a significant impact on all tax revenue sources, which results in a R304.1bn tax revenue undercollection in the current fiscal year relative to the February 2020 budget baseline. With the expected increase in liquidations and insolvencies and rise in unemployment, corporate income tax (CIT) and personal income tax (PIT) are both expected to underperform. The lower household spending due to arise from joblessness and declining household income will result in lower value-added tax (VAT) collections. The much weaker global backdrop will also impact on import duties, as countries are yet to fully open up for global trade. The combined result is a big hit to overall tax revenue collections.

While tax revenue has collapsed, spending has not. In fact, government expenditure rises by R145bn, including the recapitalisation of the Land Bank. Much of the spending is directed on frontline social and economic activities, which is necessary to save lives and livelihoods. The rise in spending results in a widening consolidated fiscal deficit to 15.7% of GDP from 6.8%. The main budget deficit rises from 6.3% as in the February budget to 14.2% for 2020, which is more than doubling over a short space of time reflecting the enormity of the economic impact. The main budget deficit is expected to moderate to 7.7% by 2022/23, which is over 5% of GDP over two fiscal years. Even more audacious is the government’s wish to reach a primary budget surplus by 2023/24. This is too ambitious, in our view, given still modest economic growth forecast.

To fund some of the R500bn COVID-19 stimulus package, government committed to reprioritise R130bn in the current budget by identifying departmental programmes that could be temporarily suspended without negatively affecting the longevity of those programmes. Through these measures, government was able to reprioritise R109bn from the 2020 Budget by getting rid of underspent funds; delaying some departmental projects to 2021/22; and suspending allocations to programmes with a history of poor performance. Despite this reprioritisation, higher spending on COVID-19 items will still result in R36bn more spending than what was expected in the February budget.

The combination of lower tax revenues, increased spending and the unavoidable switches of maturing debt in 2021 has increased the borrowing requirement to over R700bn. Debt service costs have also increased to 20 cents out of every rand spent. The debt burden is therefore forecast to rise to 82% of GDP in the current year and breaching 100% of GDP in 2024/25 in the absence of a credible fiscal consolidation path.

Government expects to borrow US$7.0bn from international lenders, including the US$1.0bn already approved from the New Development Bank, US$4.2bn expected from the International Monetary Fund and drawing down on its sterilisation deposits at the SARB. So far, no details have been provided on these funding sources. The implication for nominal bond issuance is that it is likely to increase to R10bn on average per week, including the non-competitive portion. This will likely result in difficulties for the market to absorb the increased supply; however, the SARB will likely act as buyer of last resort in the secondary market.

All said and done, this supplementary budget’s objectives fulfil the government’s second stage in a three-pronged approach to reviving economic growth that started with a lockdown followed by a R500bn fiscal package to save livelihoods. The next stage will be a recovery package that will be coupled with a reorganisation of drivers of economic growth, with an increased focus to transformation. What concerns us in this supplementary budget is the fact that much of the adjustment beyond 2020 is driven by expected expenditure cuts instead of higher economic growth. Cutting spending, especially the wage bill, has significant implementation risks.

That said, the infrastructure investment drive, should it be successful, will be a positive for the fiscus and social sustainability. It will all depend on government making the hard choices, which the Finance Minister clearly illustrated using a bible verse but never specified:

‘Enter through the narrow gate. For wide is the gate and broad is the road that leads to destruction, and many enter through it. But small is the gate and narrow the road that leads to life, and only a few find it.’ – Matthew 7:13-14.

Difficult choices and times lie ahead before the good times come and we add to the Minister’s biblical quote with a wartime quote.

‘This is like a war and in a war – one borrows a lot of money and then pays it back later. There will be a day of reckoning. We will have to have a discussion on fiscal reform, taxes, spending to pay for this ... but in the middle of a war, the goal is to win.’ – Glenn Hubbard

ENDS

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