21/02/2017
What to expect in this year's National Budget Speech - Compliments of Absa
Finance Minister Pravin Gordhan continues to face a tough juggling act between what to prioritise:
funding the economy's developmental agenda or toeing the line of fiscal discipline as recommended
by global rating agencies. When he delivered his Medium-term Budget Policy Statement (MTBPS)
last October, Minister Gordhan resolved to restore the momentum of growth to ensure that it is
inclusive and sustainable. He also sought to preserve South Africa's (SA) investment-grade status
by proposing the following:
• Fiscal consolidation acceleration.
• Stabilisation of the net national debt at 46.2% of gross domestic product (GDP) in 2017/18,
and to decline after that.
• Cutting the budget deficit to 2.4% by 2018/19.
• Cutting the expenditure ceiling by R25 billion over the next three years, mainly by curtailing
personnel spending.
• Tax increases amounting to R18 billion in 2016/17.
• A further R15 billion a year in 2017/18 and 2018/19 in tax increases.
• An additional R16 billion allocation to higher education over the next three years, funded
through reprioritisation of expenditure plans.
• R11.5 billion addition to social grant allocations over the next three years.
• Reprioritisation of funds to respond to the impact of the drought on the farming sector
and water-stressed communities.
Going into this year's Budget Speech, we believe these are the proposals that the minister will
likely expand on. He's expected to give clarity on how each of these proposals will be funded.
On the policy\legislation front, he's also expected to give an update on the following issues:
• Progress on the carbon tax bill.
• The introduction of sugar tax.
• The introduction of the tyre levy.
• Progress on consultations about mining regulatory changes.
• The latest on the minimum wage framework.
• Where we are with the reform of the retirement system given opposition by organised labour.
• National Health Insurance and progress of the pilot projects.
During his MTBPS Minister Gordhan also planned to achieve considerable savings to government,
while ensuring that procurement processes are streamlined and service providers are paid on time.
In this regard, he is expected to shed light on how he has progressed on:
• Restrictions on filling managerial and administrative vacancies and elimination of unnecessary
government positions.
• Capital budgeting reforms to align plans with budget allocations while strengthening
maintenance procedures.
• Enforcing procurement transparency and accessible reference prices for a wide range of goods
and services.
• A national travel and accommodation policy and instructions on conference costs.
• New guidelines to limit the value of vehicle purchases for political office-bearers.
• Renegotiation of government leasing contracts.
• New centrally negotiated contracts for banking services, ICT infrastructure and services,
health technology, school building and learner support materials.
On the issue of tax evasion, we expect the minister to again encourage full disclosure.
Last year Minister Gordhan pledged to continue to act aggressively against tax dodging through
transfer pricing abuses, misuse of tax treaties and illegal money flows. He said from this year,
international agreements on information sharing will enable tax authorities to act more effectively
against illicit money flows and abusive practices by multinational corporations and wealthy individuals.
Building on the expertise gained by the Large Business Centre since its establishment in 2004,
Minister Gordhan maintained that the South African Revenue Service (SARS) is well placed to
take advantage of the new Common Reporting System and that SA's international collaboration
is an essential part of efforts to ensure that the tax system remains robust and contributes to
inclusive growth. Tax evasion is said to cost developing countries $200 billion every year.
As has been the case with the 2016/17 Budget, this year's will also have to table spending
proposals that are aimed at avoiding a credit ratings downgrade. To this end Minister Gordhan
will have to balance the desire for stable and sustainable public finances, economic reforms and
a transparent monetary policy that can support a return to the higher growth rates needed to
achieve the National Development Plan's goals. Even as the minister concedes that the
macroeconomic tools at hand are limited, the government's commitment to fiscal consolidation
is what will appease ratings agencies.
Ratings agencies' concerns:
Standard & Poor's (S&P) noted in December that it could revise its negative outlook to stable if it
observed policy implementation leading to improving business confidence and increasing private
sector investment, and ultimately contributing to higher GDP growth and improving fiscal dynamics.
However, the ratings agency also raised concerns about the risks government faces in respect of
non-financial public enterprises with weak balance sheets, which may require more government support.
Along with Eskom, S&P says the state-owned entities (SOEs) that could pose a risk to SA's fiscal
outlook include National Road Agency Sanral (not rated), which is having revenue collection challenges
with its Gauteng tolling system and the South African Airways (not rated), which may be unable to
obtain financing without additional government support. Minister Gordhan will thus again be closely
watched to see how much of the country's already limited resources he will set aside for these often
dysfunctional SOEs.
Chief Investment Strategist at Absa Stockbrokers & Portfolio Management, Craig Pheiffer,
provides some thoughts below on how the budget could impact financial markets.
Impact on the rand:
The National Budget's impact on the markets will likely be transmitted via the currency market.
Market watchers will eye the Budget keenly for any announcements that might sway the credit
ratings agencies' view of our sovereign rating one way or another. As touched on above,
that view is based on key variables such as sovereign debt levels, the Budget balance,
economic growth and the expected path of those variables over the medium-term expenditure
framework. Further fiscal slippage (a widening Budget deficit) or greater than forecast debt levels
(from the October MTBPS) would be negatively received by the ratings agencies and with S&P
and Fitch, the next move lower in the offshore sovereign ratings is to sub-investment grade
(colloquially "junk" status). One could debate whether or not the current rand/dollar exchange
rate is pricing in a rating downgrade but bad news from the Budget could see a weaker
rand both in the short and long term, especially if it does lead to sub-investment grade status.
Over the course of this year, our base case remains for a R13/$ to R14/$ range, with a year-end exchange rate closer to R14/$. A weaker currency would, however, have specific consequences for inflation.
Impact on inflation:
The South African Reserve Bank (SARB) currently expects that inflation will only head back
into the 3%–6% target band in the final quarter of this year. Stubbornly high food inflation
should recede in time to help the headline CPI to average around 5.6% in both 2017 and 2018.
While this is comforting and should keep the SARB from hiking rates any time this year,
the fact that inflation is set to bob just below the upper band of 6% means that the hurdle
to any rate cuts is substantial. Interest rate risks are currently weighted to the upside (hikes)
and flat rates are predicated on some stability in the exchange rate. Over the SARB's two-year
inflation forecast period, inflation is expected to remain within the targeted range but at the very
upper end of the band. A weaker currency would cause the inflation outlook to deteriorate and
bring on the prospect of higher rates. That's where the interest rate-sensitive markets would
take their cue. Money market rates would drift higher in anticipation of a higher repo rate and
that would be good news for savers but not for a highly indebted populace. Bond market yields
would move higher and push prices lower, while the same would happen in the listed property
market where higher yields would hurt share prices.
Impact on equity markets:
Higher interest rates would also negatively impact business and consumer confidence, which are
both already at a low ebb. For domestic listed corporates, that would reduce earnings and dividend
growth prospects and impact share prices. The prospects for the local equity market, however,
are largely driven by the direction of the developed markets and the direction of the rand
(given the large number of large-capitalisation companies with primary listings or earnings offshore).
Even with static global markets, a weaker rand would provide the JSE with a boost. And while on
the face of it a price/earnings (P/E) ratio of 23-24x appears expensive, there are a number of
anomalies that once removed, make the P/E look a lot more modest (such as the 80x P/E of 15%
weighted Naspers). The ongoing recovery in the earnings of resources companies should help lift
total market earnings growth and even with some de-rating of the market P/E, a total return from
equities of around 10% could not be considered unreasonable.
The MTBPS that was tabled in October reflected a weaker fiscal position than was presented in
last year's February National Budget, so the market has already been sensitised to this fiscal slippage.
We strangely escaped personal income tax (PIT) increases last year and it is very likely that
Budget revenues will be boosted by higher PIT this time around. That could well help with preventing
any further fiscal slippage from the MTBPS in this Budget, even with a very slow growing economy.
Any additional credible growth initiatives would also be very well received and overall there is a
scenario where SA could escape a ratings downgrade once more. That kind of expectation would
help the rand to rally and have positive impacts on the rate-sensitive markets but that would
probably still be short-lived. Whichever way it goes, the markets will keenly watch the pronouncements
of the Finance Minister, whoever that may be at the time.
Kind regards
Absa Insurance and Financial Advisers
