It is imperative that the treasury use today's medium-term budget policy statement (MTBPS) to reassure the market of its commitment to fiscal sustainability. Brazil’s recent experience demonstrated that the global economic environment has become a lot less supportive of emerging markets – especially those running large deficits and in need of funding.
In Brazil’s case, it was assumed that the credit rating downgrade was fully priced in, but this turned out not to be the case. The downgrade to below investment grade had significant implications for credit spreads, and Brazil’s borrowing costs have risen.
If South Africa is to retain its investment grade rating, the treasury has to make its budgetary discipline clear. However, this is not without its challenges.
How to raise income and cut costs?
Firstly, the treasury will have to downgrade South Africa’s growth forecasts yet again. This raises real risks for revenue projections, which are based on higher GDP forecasts. Given weak corporate taxes and a weak domestic economy, personal income tax growth is likely to be much more muted than expected. This means the treasury will have to demonstrate where they are going to get extra revenue from.
We also need to see how expenditure is going to be controlled. The public sector wage agreement that was concluded in May this year was higher than expected, for current and future years. Therefore, the treasury will have to remove money from other spending priorities to keep the framework intact. The one thing the government cannot do, is breach the expenditure ceiling for the next three years that they announced in the February Budget.
A taxing issue
Furthermore, the lower growth outlook also increases the risk of tax increases. In this year’s Budget speech, small increases to personal income tax were announced, but in order to continue raising revenue, it may be necessary to do more than that.
While it may not be a politically popular topic, the treasury might do well to investigate increases to VAT. The Davis Tax Committee’s report showed that, of the three major sources of tax (corporate, personal and consumption), raising VAT was the least disruptive option in the subsequent 12-24 months, in terms of employment and economic growth.
One thing that is certain, is that the rating agencies will keep a keen eye on the tone of next week’s statement. While Moody’s and S&P may be on hold for now, the only thing that could stave off a downgrade from Fitch in December (to one notch above non-investment grade) is a budget that is much more focused on reining in debt to GDP than was the case in the February budget.
The environment continues to get more challenging for emerging markets, but those countries that show a clear focus on increasing their long-term growth rate will continue to attract investment. South Africa can do this by implementing much needed reforms, such as allowing more private sector participation in the energy sector or resolving the crippling visa requirements. A higher growth rate is the only long-term solution to South Africa’s budget constraints.