Credit rating risk

Deficit targets missed.

Lower than expected tax revenue and a once-off R15 billion reduction in UIF contributions will see South Africa’s finance ministry miss its deficit targets.

The consolidated budget deficit (the difference between revenue and non-interest spending) of 3.9% is wider than the 3.6% that was estimated in the 2014 medium term budget policy statement (MTBPS). However it must be taken as a positive sign that Treasury is finding traction in its efforts reduce the deficit, which has been stuck at around 4% or more for the past five years.

The 2015 budget affirms government’s commitment to narrow the budget deficit, stabilize debt and begin to rebuild fiscal space.

The government plugged the hole in the budget by increasing taxes by R16.8 billion in 2015/6 as a result of higher personal income tax rates and a 30.5c/litre increase in the general fuel levy. The R95 billion deficit in the Road Accident Fund will be subsidised by an increase in the RAF fuel levy of 50c/l – generating R9 billion over the next two years.

In addition, relative to expenditure levels announced in last year’s budget, total spending in the next two financial years has been reduced by R25 billion, or 1% of projected budgets.

This affirms government’s commitment to driving growth by investing in infrastructure rather than consumption. The bulk of reductions came out of goods and services budgets.

Whether this will be enough to convince markets and rating agencies that government is committed to lowering South Africa’s deficit, remains to be seen.

“Fiscal consolidation provides the backbone for SA maintaining its’ investment grade rating, with fiscal slippage being a key contributor to recent downgrades,” says Old Mutual Investment Group chief economist, Rian le Roux. “Ultimately, raising taxes to ensure the reduction of our deficit is a small price to pay for the alternative, which is the risk of being downgraded to junk status, a slump in the rand, surging inflation and higher interest rates.”

Government as well as the ratings agencies know that there is no room for complacency. A debt level of 44% of GDP is not far from the 50% level suggested by a recent research piece of an International Monetary Fund employee to be the safe maximum debt-to-GDP ratio.

Debt service costs continue to be the fastest growing component of main budget expenditure, increasing by 10.1% in nominal terms over the medium term. The costs of financing government debt are projected to increase from R115 billion in 2014/5 to R153.4 billion in 2017/18 accounting for 3.1% of GDP.

Government’s net borrowing requirement of R180.9 billion in 2014/5 is R1.1 billion higher than projected in last years budget and is expected to decrease to R173.1 billion in 2015/6.

Lower inflation should support government efforts to reduce the deficit by allowing departments to buy more goods and services without breaching expenditure ceilings and may facilitate a sustainable wage agreement.

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