Sanlam: MTBPS 2017 – A plea for more time, but no consolidation Sanlam: MTBPS 2017 – A plea for more time, but no consolidation
The MTBPS 2017 is a plea for more time and support to implement new economic policy. It does not attempt to quantify the potential... Sanlam: MTBPS 2017 – A plea for more time, but no consolidation

The MTBPS 2017 is a plea for more time and support to implement new economic policy. It does not attempt to quantify the potential impact of these interventions. Rather, it shows what the Budget would look like should there be no policy action and/or additional fiscal consolidation, says Arthur Kamp, economist at Sanlam Investments.

Without interventions, we can expect a materially higher, sustained increase in the gross loan debt ratio to 60.8% of GDP by 2021/22 from 50.7% of GDP at end March 2017. Meanwhile, interest payments will increase persistently from 13.7% of Main Budget Revenue in 2017/18 to 14.9% by 2020/21.

What kind of interventions could avert the above scenario?

The MTBPS 2017 states a team of cabinet ministers will develop proposals to “stabilise the national debt over the medium term”, including proposals to narrow the deficit and ensure the expenditure ceiling is adhered to in the current year. Further, asset sales are being considered over and above additional fiscal consolidation measures, including expenditure cuts and revenue-raising measures, which are mooted for the 2018 Budget.

The MTBPS also makes it clear new spending priorities, which could include National Health Insurance, fee-free higher education, improved early childhood development, accelerated land reform and infrastructure spending, should be financed by structural increases in revenue and reprioritisation of existing expenditure. Hopefully, that implies faster growth and efficient tax collection, rather than new taxes. Treasury could also turn to reducing tax expenditure. For example, it is considering adjustments to the medical tax credit to help fund NHI. These credits resulted in tax expenditure of R18.5 billion in 2014/15, but are effective in supporting lower income earners.

The ratio of government expenditure to GDP keeps increasing

It was never realistic to expect the Minister to announce sales of state assets or plans to improve the finances of state-owned companies (SOCs) in MTBPS 2017. Government’s Inclusive Growth Plan indicates an audit of non-strategic assets and plans for reform of SOCs, including finalisation of development mandates, will not be completed before March next year.

However, at the very least, an announcement of additional fiscal consolidation measures was expected.  Historically, there has been a place for revenue increases in some fiscal consolidations, but in the end, successful fiscal consolidation usually features expenditure cuts. But, although the Treasury sticks to the absolute level of the expenditure ceiling more or less, the ratio of expenditure to GDP keeps increasing, which maintains pressure on the Budget balance.

Accordingly, after increasing to -4.7% of GDP in 2017/18 from -3.8% in 2016/17, the Main Budget deficit decreases only marginally over the medium term to -4.6% of GDP by 2020/21. Concomitantly, the consolidated Budget deficit increases to -4.3% of GDP in 2017/18, from -3.3% of GDP in 2016/17, before decreasing to 3.9% of GDP by next year fiscal year.  The former is, nonetheless, important as regards the Treasury’s gross borrowing requirement.  Net loan debt (gross loan debt less government’s cash balances) is also expected to increase – to 55.6% of GDP by end 2020/21 from 45.6% of GDP at end March 2017 – absent any fiscal consolidation.

Treasury’s revenue collection track record disintegrates

In addition to accepting lower tax buoyancy (i.e. the response of revenue collection to changes in GDP growth) the National Treasury lowered its nominal GDP growth projections over the medium term to plausible levels. This decreased expected government revenue by R50.8 billion, R69.3 billion and R89.4 billion in fiscal years 2017/18, 2018/19 and 2019/20 respectively – even though South African Customs Union payments were revised down by R14.1 billion and R19.8 billion in 2018/19 and 2019/20 respectively. The outcome is in line with expectations and it remains to be seen what additional revenue-raising measures are announced in February 2018 (R15bn in additional revenue-raising measures was announced in February this year).

Rescuing SOCs threatens Treasury’s hitherto good expenditure track record

More telling was the absence of meaningful expenditure cuts to adjust to the reality of an underperforming economy. Indeed, the Minister indicated an expected expenditure overshoot of R3.9 billion in the current fiscal year even after absorbing contingency reserves of R6 billion.  Thereafter, expenditure is cut by R7 billion and R15 billion in 2018/19 and 2019/20 respectively, but this merely reflects running down the contingency reserve.  Moreover, the Treasury highlights the risk posed to the ceiling by next year’s public sector wage negotiations and other new spending priorities.

At first glance, the expected expenditure overrun in 2017/18 is surprising, given the marked slowdown in expenditure growth in the first five months of the fiscal year. However, appropriations of R13.7 billion have been included for SAA and the SAPO, a worry in that the goal of Treasury in recent years was to keep the funding of SOCs deficit neutral.  This turns the focus on Eskom’s request for a substantial tariff increase next year, failing which the risk to the Treasury could increase. Meanwhile, the Treasury states Denel, South African Express and the South African Broadcasting Corporation are experiencing liquidity difficulties.

The MTBPS numbers no longer reflect an intent to stabilise the debt ratio

Previously, the National Treasury’s positive intent to return government’s finances to a sustainable position was clearly demonstrated by the persistent decrease in the Main budget primary deficit (revenue less non-interest spending) from -2.7% of GDP in 2012/13 to -0.5% of GDP in 2016/17. However, the primary deficit increases to -1.2% of GDP in 2017/18.

An improvement is shown to a primary deficit of -0.7% of GDP in 2019/20, but given the gap between the real interest rate on government debt and real GDP growth this is not sufficient to prevent the debt ratio from increasing. Accordingly, government’s gross loan debt increases persistently over the next three years.

Persistent decline in government net worth illustrates the scale of the problem

A return to a sustainable fiscal path requires less consumption spending and more capital expenditure, protection of the government’s balance sheet and alignment of the tax structure with the growth objective (that is increased consumption taxes rather than taxes on income and savings). None of this is evident in the Budget and is reflected in the persistent decline in government’s net worth – a key indicator of an unsustainable fiscal path.

It is difficult to accurately gauge the extent of fiscal slippage from the MTBPS, since it excludes the impact of fiscal consolidation measures likely to be announced in February 2018. Indeed, the fiscal outlook may be a little less daunting than currently shown. Even so, it is becoming increasingly clear that the current fiscal path is not sustainable.  The debt ratio has not been stabilised, the ratio of capital expenditure ratio to GDP is not increasing and the share of government consumption in GDP remains high (reflecting a large wage bill). Specifically, general government fixed capital stock has declined from close to 90% of GDP in the early 1990s to less than 60% of GDP currently, while the debt ratio is currently more than 50% of GDP – similar to the level of the mid-1990s (and as noted is set to continue increasing).

Hence, government net worth (measured as capital stock minus liabilities) has been on a persistent deteriorating trend. The general government has borrowed to finance consumption rather than investment. Moreover, contingent liabilities in the form of debt guarantee exposure to public institutions amounted to almost 7% of GDP by end March 2017 and could increase to around 10% of GDP in three years’ time.

What does the MTBPS mean for our credit rating?

Attention will no doubt now turn to the rating agencies. Given the macroeconomic outlook for the next two years, we think the S&P long-term foreign currency debt rating for South Africa at BB+ (sub-investment grade) seems fair for now. But, the domestic currency rating is more at risk in the absence of additional fiscal consolidation measures.

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