Budget 2022: right intent,

but tough road ahead

The projections included in Budget 2022 align closely with prior expectations and show a material improvement relative to the initial February 2021 projections. Given a gross tax windfall of R181.9 billion in the current fiscal year, the updated Main Budget deficit estimate of -5.5% of gross domestic product (GDP) for 2021/22 is substantially lower than the initial projection of -9.0% of GDP published in February 2021. As a result, the government’s gross loan debt ratio is expected to decrease to 69.5% of GDP at end March 2022, from 70.7% of GDP at end March 2021, although this reflects a temporary pause in the upward trajectory of the ratio.

Looking forward, the most notable feature of Budget 2022 is National Treasury’s intent to return fiscal policy to a sustainable position, as it aims to ‘save’ a significant portion of its current tax windfall for this purpose. The gross loan debt ratio is now expected to peak at 75.1% of GDP in 2024/25. This compares with the peak of 78.1% of GDP in 2025/26 projected in the November 2021 Medium-Term Budget Policy Statement.

Treasury’s revised revenue estimates show a cumulative increase in Main Budget gross tax revenue of R468.5 billion from 2021/22 to 2023/24, relative to its projections published in February 2021. Ideally, this bonanza should have been ‘saved’ in its entirety to lower the debt trajectory even further. After all, debt sustainability is a precondition for eventual sovereign debt rating upgrades, which, all else being equal, would lower borrowing costs and free up resources for spending elsewhere. In the fiscal year 2022/23, Main Budget debt servicing cost is expected to amount to R301.8 billion. Put differently, the government’s interest bill absorbs 19% of Main Budget revenue in the new fiscal year.

WINDFALL ABSORBED BY SPEND

However, South Africa’s depression-level unemployment rate precludes an ideal outcome. Additional Main Budget non-interest spending amounted to R63.1 billion in 2021/22, relative to the initial February 2021 projection. And in 2022/23 and 2023/24, non-interest spending has been lifted by a further cumulative R195.2 billion. This implies that more than half of the upward revision to tax revenue over the three years from 2021/22 to 2023/24 is absorbed by additional spending. Thereafter, in 2024/25, non-interest spending is lifted further by R87.1 billion.

Part of the upward revision reflects the cash gratuity granted to government employees in 2021/22 and 2022/23, which should fall away over the medium term. However, it is clear that South Africa’s pressing socio-economic needs, which cannot be ignored, are translating into higher government spending.

As such, the revisions include additional spending of R48.2 billion on social welfare interventions and free basic services (mainly social grants spending) in 2022/23. This expenditure category has also received additional allocations of R16.7 billion and R22.6 billion in 2023/24 and 2024/25 respectively. Further, given potential additional spending pressures, the adjustment includes unallocated reserves (over and above the contingency reserve) of R25 billion and R30 billion in 2023/24 and 2024/25 respectively.

RISKS TO DEBT TRAJECTORY

The Main Budget deficit decreases to 4.5% of GDP by 2024/25 from -5.5% of GDP in 2021/22, while the Main Budget primary budget balance (revenue less non-interest spending) turns into a surplus of +0.6% of GDP in 2024/25 from a deficit of -1.3% of GDP in 2021/22. However, this is not sufficient to stabilise the debt ratio over the medium term.

Debt stabilisation is still some way away and the likely final debt trajectory is subject to a range of risks – both positive and negative, including the extent to which tax administration efficiency improves, the duration of the commodity price boom, potential tax regime changes (which influence tax buoyancy) and any potential proceeds from asset sales.

But over and above these factors, the standout risk relates to planned expenditure restraint. Partly reflecting joblessness, the expenditure track record of recent years is one of continuous slippage. Moreover, whereas wage restraint lies at the heart of South Africa’s fiscal consolidation drive, a formal wage agreement must still be signed.

Overall, it remains a tough task to limit the average annual real increase in consolidated non-interest spending to 0% (+1.6% excluding compensation of employees) over the medium term as projected by Treasury.

BORROWING REQUIREMENTS

At the same time, the government’s gross borrowing requirement increases to R484.5 billion in 2022/23 from R412.0 billion in 2021/22, including an increase in gross long-term debt issuance from R285.3 billion to R330.4 billion. However, Treasury has given no indication of potential loans issued for switches or issuance of floating rate notes or Sukuk bonds.

Treasury further intends using R106.2 billion of its cash balances in lieu of issuing short-term debt in 2022/23, while expected foreign funding amounts to R47.9 billion (in line with previous projections). Interestingly, Treasury has indicated foreign long-term loan issuance of R80.6 billion in 2021/22, whereas it had issued just R16.3 billion net foreign loans by January 2022.

The borrowing requirements for 2023/24 and 2024/25 are similar at R487.6 billion and R479.3 billion respectively, and include a slight increase in long-term debt issuance relative to 2022/23.

ELUSIVE PATH TO LOWER DEBT RATIO

Ultimately, intent is important. Fiscal policy should be designed for long-term sustainability, including alignment of government spending with the underlying potential growth rate of the economy. This implies expenditure restraint when temporary windfalls boost revenue. And it requires economic reform and the alignment of tax policy with the growth objective, that is, broadening of the tax base and designing tax policy so that the incentive to work, save and invest is not reduced.

Budget 2022 makes a concerted effort to meet the first objective, but still aims to spend a sizeable portion of the revenue windfall.

As regards the tax regime, Budget 2022 provides a net R5.2 billion in tax relief. However, the changes to the direct and indirect tax regimes are limited and probably won’t lift growth by much.

On balance, therefore, although Budget 2022 is a significant improvement on previous projections, which should alleviate sovereign debt ratings risk for now, low potential economic growth and high spending needs constrain Treasury’s ability to show a decisive path to a lower debt ratio over the medium term.

Commentary by Alwyn van der Merwe, Director of Investments:

In assessing South Africa’s fiscal health, it’s clear that the windfall of an additional R181.9 billion in gross tax revenue has resulted in an improvement of all the important fiscal ratios. These cold numbers should provide some relief for those concerned about South Africa’s ability to honour its future fiscal commitments.

However, in reality, our country’s socio-economic requirements have not allowed Minister Godongwana to ‘save’ or to put most of this windfall to work to generate the economic growth desperately needed to create employment and ultimately widen the tax base for sustained fiscal income over the longer term.

Although in our view the Budget Speech is only one of many factors driving equity sentiment, investors are likely to view it in a positive light. The fact that a material portion of the tax windfall could find its way into the pockets of government workers or to increased payments of grants, and that the Minister has fully compensated taxpayers for the impact of fiscal drag, is likely to boost consumer spending. This should generally support the demand for consumer goods – which is good news for retailers – and should also benefit banks as their clients’ after-tax revenue stream should receive a moderate boost.

Local bond investors are likely to have mixed views on Budget 2022. While they would in the main credit the Minister for his intent to apply constraint in spending the tax revenue windfall, they might have expected more discipline in this regard.

It was also rather obvious that tax revenue was going to surprise on the upside. Bond investors generally believed that this would lead to a very limited or even zero increase in gross long-term debt issuance. The increase from to R235 billion to R330 billion therefore came as a negative surprise.

In the final analysis, the overall outcome is certainly better than the expectations held at the beginning of the fiscal year, and the immediate risks for the local bond market are markedly lower when compared with the dilemma we faced in the midst of the 2020 economic slump.