50% chance or greater of downgrade after mini budget
28 October 2016
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On mobile, on digital, on demand, this is Old Mutual Live, Money Coach. Hello and welcome, my name is Chris Gibbons. So, Finance Minister Pravin Gordhan has delivered his medium term budget policy statement, or the mini budget as it’s more easily known. Gordon finds himself in a tough position, a stagnant economy, rising government expenditure and falling tax collections.
All of this against a very intimidating political backdrop and under the watchful eyes of the Big Three ratings agencies. How does all of this affect us, the ordinary South African? We’re joined now by Old Mutual Strategist, Izak Odendaal. Izak, welcome once again to Old Mutual Live Money Coach, first off, what was your overall reaction?
Izak Odendaal: Look, I think as you said, it is a very challenging environment for the Minister to try to put together a budget, primarily because the economy is so weak. When you have a weak economy, you don’t have a lot of tax revenue to work with. Also in the weaker economy you have a lot of demands on spending.
We saw the students up in arms over free education, they are probably the most vocal party at the moment. But there are many interest groups in SA who are clamouring for more spending from government side, so that is the backdrop.
Gordhan sticking to his budget guns
How did he do? I think he did okay, given this tough environment. I think importantly he stuck to the path of fiscal consolidation. What that means simply is to try and reduce the amount of money that government is borrowing every year.
So the idea is to gradually, over the next three years, reduce the amount of money that government has to borrow, that’s the deficit. The reason we have to do that is because at the end of this two-year period, current projections already say that you are going to spend, the government will spend R200 billion on interest payments. As a consequence of all the borrowing that’s happened in the past.
Obviously that becomes unsustainable and that starts crowding out other important areas of spending in your budget. So you have to get that under control, that is the so-called fiscal consolidation. But you also cannot do it too quickly. You cannot hike taxes too much, you cannot cut spending too quickly.
Because it has an adverse effect on service delivery, it has an adverse effect on companies and households and the economy. It is in many sense a balancing act. I think given the tough environment and given all the balls he’s had to juggle, I think it was a fairly credible budget.
CG: What were the key points for you?
IO: The key points, number one, they’re sticking to this path of fiscal consolidation. They will gradually narrow the budget deficit over the next three years. Although it won’t happen, the space of consolidation is not going to happen as fast as they promised in February. Because the economy is a lot weaker than they thought it would be in February and tax revenue has thus fallen short. They have sort of stuck to that broad plan.
The second, the reality is we will see tax increases of in some form or shape over the next couple of years and that is obviously not good news for consumers. Thirdly, I think there’s a great emphasis on trying to contain costs within government. Obviously if you are telling South Africans they’re going to have to pay more tax, government also has to demonstrate that it’s spending money wisely and carefully.
The Minister did highlight one or two items where they have already achieved significant savings, but there will have to be quite big savings in the next three years. Part of that, according to the Minister, is going to come from headcount reductions at government departments. So they’re going to rely on attrition to reduce the number of people who work for government.
How will this effect us?
CG: What does it hold for the ordinary South African, the ordinary man and woman in the street?
IO: Unfortunately, the message is one where there will be tax increases next year. We don’t know exactly how, it’ll probably be a combination of different things. A fuel levy, those sin taxes on cigarettes and alcohol, possibly a re-shuffling of the income tax brackets. So somehow there will be more money taken out of your pocket. You might not necessarily notice it, it might not necessarily be a big headline tax rate increase, but there will be a bit less money to spend next year.
By the same token the government services that you rely on, those will continue to receive a reasonable level of funding. He hasn’t exactly taken an axe to healthcare and education and so on, I think that is positive. If you’re relying on those kinds of services, at least there will be some increases in spending in that regard.
Could we see a VAT increase?
CG: Looking ahead, February 2017, not going to be a good month, ordinary folk, is an increase in VAT politically feasible?
IO: I don’t think it is unfeasible, I think the main thing is you don’t want to hike VAT in an environment where consumer spending is under so much pressure already. I think VAT really is the last resort when it comes to tax increases, although our VAT rate is quite low by global standards. There’s definitely scope to increase that, from that point of view.
that is very efficient in terms of the amount of money that you can gather, relative to the efforts that you have to put in. But I don’t think VAT is quite on the cards just yet, potentially 2-3 years out in the future we could be talking about it again, if the economy is a bit stronger.
CG: You’re listening to Old Mutual Live, the Money Coach edition, on demand, visit dogreatthings.co.za. Izak, final question, does this stave off a ratings downgrade?
Have they done enough to stave off a ratings downgrade?
IO: That’s the question on everyone’s lips isn’t it? My answer would be yes and no. On the yes side, I think the numbers that the Minister put forward this week, should be okay to maintain our ratings. I think they’ve more or less done the things that the ratings agencies want when it comes to putting together a plan for government’s finances, for the fiscal position of the country.
Where we’re falling short relative to what ratings agencies want is that they want to see faster economic growth. The reason they want to see faster economic growth is because if your economy is growing fast, your incomes are growing fast, debt is not a problem. Debt is a problem when income is under pressure.
From their point of view, our debt is only sustainable if our economy grows a lot faster. They want to see measures that will result in sustainable and rapid economic growth in the next couple of years, not just now. But over the longer term and unfortunately the budget fell quite short in terms of those measures.
In February the Minister said that the government was looking at a whole number of things in terms of private sector participation, in terms of labour market reform, in terms of reform at state owned enterprises. I was hoping to see a bit more detail on those measures.
What he said this week was really that that’s all still a work in progress. From that point of view the ratings agencies will be disappointed. I think the chance of a ratings downgrade is still greater than 50%, from at least one ratings agency within the next year or so.
CG: And there we’ll leave it. This has been another edition of Old Mutual Live Money Coach, my name is Chris Gibbons. I’ve been talking to Old Mutual’s Strategist, Izak Odendaal. Izak, thank you for joining us on Old Mutual Live Money Coach.
Remember, please feel free to get in touch any time if you have any questions for me, topics you’d like me to cover here on Old Mutual Live Money Coach. Just send them direct to me at firstname.lastname@example.org, I would be delighted to hear from you. Until the next time, thank you for listening. Old Mutual Live, on mobile, on digital, on demand.