South Africa’s stock market underperformed compared with its emerging-market peers in 2019, as the FTSE/JSE All Share delivered 12% compared to the MSCI Emerging Markets Index’s 15% gain. With the local economy teetering on the brink of recession, tax collection falling woefully short of National Treasury’s targets, and unsustainable spending and debt obligations, Finance Minister Tito Mboweni’s budget speech will be closely watched for evidence of fiscal discipline and policy direction.

The speech, scheduled for Wednesday 26 February, is a key bellwether on the state of the economy and the fiscus, and an important indicator for policy direction at a time when there is little much-needed progress in reform. Credible signs of government’s willingness to do what is necessary to reduce spending, stimulate growth and make hard choices regarding state-owned enterprises (SOEs) could do a great deal to improve investor sentiment.

Wiggle room

Minister Mboweni has little room to manoeuvre. Moody’s Investor Services has cited the rise in government debt as a key concern. Tax collection was short to the tune of R60 billion at the time of the Medium-Term Budget Policy Statement in October 2019, and since then the economic outlook has deteriorated even further with the re-introduction of routine load shedding, and the bailouts of SOEs – most notably the recent funding line extended to SAA.

South Africa’s souring creditworthiness is a key risk to further rating downgrades. Moody’s currently holds South Africa’s last investment grade rating, and its reaction to Mboweni’s speech could have far-reaching implications.

A sub-investment grade rating would, in all likelihood, lead to a near-term sell-off in bonds and the rand, which would in turn raise the cost of government debt. With a weaker rand feeding into higher inflation, there is a good chance that January’s surprise interest rate cut could be reversed, which means higher prices and higher interest rates for South African households.

A stay in the execution of a downgrade would buy South Africa more time to implement reforms, but the willingness to do so to date is increasingly concerning.

The options

1. Bonds

In the short-term, further expanding government debt through issuing new government bonds and increasing state bond yields is one option to help finance South Africa’s budget. But, with debt servicing costs the fastest growing budgetary line item for the past few years, this is not a sustainable option in the long-term – and may not even be a viable option in the short term.

Should Moody’s choose to downgrade South Africa, either post Mboweni’s budget speech or at another point this year, the interest rate offered on government bonds would have to increase, further adding to the country’s debt burden and increasing the likelihood of further downgrades.

2. Taxes

  • (PIT) Private income tax

PIT will most likely be increased in February to meet the budgetary shortfall. However, this may not come in the form of higher tax rates, but through a mechanism called bracket creep, where inflation pushes tax payers into a higher tax bracket. There is a chance that tax rates will be hiked, but this seems to be a relatively low probability given the economic environment.

  • (CIT) Corporate income tax

There is limited room to manoeuvre with CIT given that South Africa’s tax rates are already amongst the highest globally (28% versus an average of 24%). Indeed, the Davis Tax Committee recommended no further increases to CIT lest corporates be encouraged to find more favourable business environments overseas.

  • VAT (Value-added tax)

Despite VAT being raised from 14% to 15% over 18 months ago by then-Finance Minister Malusi Gigaba, this increase has not been the boon to government coffers that was hoped. Although a further increase in VAT to 16% is likely to be met with fierce opposition given its disproportionate impact on the poor, this seems like a growing probability given the limited options available. A socially more palatable avenue could be to include a luxury VAT rate. If this is introduced, it would probably only collect small amounts of tax revenue at the cost of higher administrative complexities for business.

3. Prescribed assets

At the ANC’s policy conference in 2017, a resolution was passed for the introduction of prescribed assets with a view to boosting infrastructure and skills development. While not government policy, Cosatu recently called for the prescription of private pension money to fund infrastructure and SOEs, including Eskom. The implications of this avenue need to be carefully considered. There is evidence of successful asset prescription in other countries, but one of the necessary conditions is that the assets funded are “viable” or will deliver solid investment returns. South Africa’s SOEs have ground to make up to lay claim to this status.

Towards an economic policy for South Africa

Ongoing policy polarisation within the governing ANC on various contentious issues has resulted in the delay of the reforms needed to ignite growth. With the introduction of the NHI, the recent announcement that expropriation without compensation would be implemented in such a way as to bypass the courts, and labour unions’ determination to safe-guard jobs, policy reform has stagnated at best, and taken some significant steps backwards at worst.

Mboweni’s statements on the fate of troubled SOEs such as Eskom and SAA (both beneficiaries of multiple bailouts in recent months) will reveal much on government’s willingness to make the hard decisions needed to spur growth.

National Treasury’s policies as outlined in its economic policy document offer a viable short-, medium- and long-term path to growth. Only by eliminating corrupt and wasteful government spending on the one hand, and growing the economy, creating new job opportunities and so increasing the tax base on the other hand, will National Treasury be able to stabilise the country’s finances.