From a widening deficit to lower-than-expected revenue collection, the Medium-Term Budget Policy Statement (MTBPS) presented by Finance Minister Enoch Godongwana early in November painted a gloomy picture of South Africa’s fiscal position, but some experts believe that it was still, in a sense, a positive budget speech.

“This was a face-the-music budget with no attempt to sugar-coat things,” says Izak Odendaal, Chief Investment Strategist at Old Mutual Wealth.

“Minister Godongwana certainly talked the talk, and the question now is whether he can walk the walk, especially given the many decisions that are outside his control.”

The budget may also have alluded to some future pressure on taxpayers, with tax revenues for the current fiscal year expected to be around R57 billion lower than projected in February.

However, Odendaal notes that there is a limit to how much more of a tax burden the economy can stomach, also considering that tax revenue as a share of GDP is already on the high side for a developing economy like South Africa.

The government attributed the increased deficit largely to lower corporate tax revenues and higher VAT refunds. SARS Commissioner Edward Kieswetter pointed out that year-on-year gross revenue collection was up 7%, but that net revenue collection contracted significantly on the back of several factors directly linked to rolling blackouts and the failing freight rail system.

Kieswetter says the decline in corporate income tax can be attributed more broadly to increased input costs as a result of inflation and the high capital costs incurred by companies investing in alternative energy solutions to overcome the challenges posed by blackouts.

A pragmatic view

The budget deficit, or the gap between spending and revenues that must be funded by borrowing, will be 4.9% of GDP this year, instead of the 4% that was projected in February.

Johann Els, Group Chief Economist at Old Mutual, says in the face of a multitude of pessimistic revisions such as the above, this medium-term budget presented a pragmatic outlook.

“The budget's assumptions are firmly rooted in realism, recognising the challenges of achieving robust revenue growth. Additionally, the MTBPS remains committed to delivering on the promised expenditure reductions,” he says, adding that the assumptions underpinning this budget are not only credible but also conservative, mitigating the likelihood of further market shocks.

Addressing government debt

The reality remains that the South African government pays a high interest rate to borrow from the bond market.

“This means that the government now spends more on interest payments than most other line items in the budget, and this number is growing rapidly,” says Odendaal.

In the current fiscal year, debt service costs are expected to be R354 billion, a staggering amount equal to 5% of GDP. Other important spending areas are squeezed out when around 20 cents out of every tax rand collected goes towards interest payments.

The challenge with this is that as South Africa goes further down the debt spiral, so too does investor confidence – seen in the outflows as foreign investors cut their holdings of South African debt.

Odendaal says South African investors still have a strong demand for high-income paying assets, but that it’s not infinite.

“In particular, bank holdings of government securities have already doubled in the past five years and it’s unlikely that it can increase further without increasing risk for banks to unacceptable levels.

“Stronger economic growth would imply more money going into pension funds as more people work and salaries rise, supporting demand for government bonds,” he explains.

Yet Odendaal adds that South African government bonds still offer very attractive real yields across the yield curve.

“From 8.7% for one-year bonds to 12% for 30-year bonds, investors can earn a substantial real income even with pessimistic assumptions of future inflation. And with a conservative Reserve Bank in charge of inflation management, inflation should remain well-behaved in the years ahead,” he says.

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