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Treasury likely to meet fiscal targets in mini-budget, despite pressures

MTBPS could focus on continued fiscal consolidation.

While the economy undeniably remains in a vulnerable position, the overall economic environment has shown signs of improvement from earlier this year.

This is according to Johann Els, senior economist at the Old Mutual Investment Group, who is cautiously optimistic looking forward to the Medium-term Budget Policy Statement (MTBPS), which is to be delivered by Finance Minister Pravin Gordhan on October 26 2016.

“Times are still difficult and pressure remains on National Treasury to keep to February’s fiscal targets – one of the key requirements in the efforts to maintain South Africa’s investment grade credit rating – however, we believe that Treasury will mostly be able to meet these targets, despite downward pressure on revenue from a weaker than expected economy,” comments Els. In February, Treasury forecast GDP growth of 0.9% this year, while Els’ forecast for Old Mutual Investment Group is for 0.5% growth.

Els believes that the MTBPS will likely focus on continued fiscal consolidation as promised in February. He says that market participants and ratings agencies will look for continued adherence to Government’s own expenditure ceiling, any possible hints regarding tax changes, possible announcements around strengthening of state-owned enterprise (SOE) finances and growth enhancing policy announcements. “Despite additional expenditure pressure – such as the possibility of further university funding – we expect Government to be able to maintain adherence to the expenditure ceiling. They will have the benefit of the contingency reserves as well as likely savings from the Office of the Chief Procurement Officer,” he says.

“Although downward revision to Treasury’s own growth forecast would likely lead to somewhat lower revenue growth, strong non-tax revenue, as well as the likely impact of fiscal drag later in the fiscal year, this could mean that the revenue undershoot is unlikely to bust the deficit target in any significant way,” he adds.  “Although extra tax revenue for 2017 was already announced in February, with more tax measures likely needed in future, we do not expect any concrete announcement in the MTBPS yet. There might be some hints regarding tax changes – which we expect to mainly target the top income groups – through a lack of fiscal drag relief, increased dividend and/or capital gains taxes, and maybe even another top marginal rate.”

“Domestically, a combination of stronger second quarter GDP data, improved growth forecasts and lower levels of inflation, all appear to be steering the market away from further rate hikes this year and towards our own expectation of rate cuts in the second half of 2017.”

Els does, however, acknowledge the threat that recent political uncertainty poses to the headway already made by Treasury since February’s Budget. “The market likes certainty and the political pressure on the current, globally respected finance minister is weighing on sentiment, potentially undoing all the hard work that has gone into avoiding a sovereign ratings downgrade.”

In line with undertakings made to ratings agencies, Els mentions various pro-growth policy announcements that are expected to be made at or around the time of the MTBPS, but predicts that Treasury will continue to ignore nuclear spending. “We expect announcements around the national minimum wage, secret strike ballot, mining charter, and perhaps state-owned enterprise governance.”

Peter Brooke, fund manager of the Old Mutual Flexible Fund, echoes Els’ sentiment that Treasury’s main priority will be in adhering to the expenditure ceiling that was introduced to keep the fiscal numbers on the right track.

However, as Brooke points out, Gordhan will have the difficult task of finding an acceptable balance between the seemingly conflicting priorities of the rating agencies and the public sector. “In spite of growing demands for additional allocations of funds, such as the widely recognised need to increase the subsidy to higher education institutions, ratings agencies will be focussed on whether Treasury has managed to control spending,” explains Brooke.

Another significant interest to ratings agencies in the MTBPS lies in the status of SOEs, continues Brooke. “The growing liability of state-owned enterprises is understandably a major focus point, as potential losses directly impact the amount of pressure placed on the fiscus.”

In the event that a downgrade does occur, Brooke explains that the greatest impact will be on investor confidence and the amount of interest South Africa pays on its debt, as opposed to asset prices. “Due to general sentiment, markets have already priced in the likelihood of a downgrade and asset prices have moved accordingly, therefore the damage from a downgrade will be somewhat contained regarding short-term shocks. The real damage will be that caused to investor confidence, which is already sitting at alarming low levels, and the increased interest charges on our estimated debt of almost R2 trillion.”

Given the context, both Els and Brooke agree that the upcoming MTBPS is one of the most eagerly anticipated in SA’s democratic history. “This is arguably one of the most significant mid-term policy statements to be delivered in South Africa yet and we expect that Treasury will do their utmost to direct the budget towards a position where a ratings downgrade can be averted. However, whether their efforts, in the current uncertain political environment, will be enough remains to be seen,” concludes Els. 

Johann Els is a senior economist at the Old Mutual Investment Group

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