On the 22nd February the Minister of Finance, Pravin Gordhan, presented a budget that tries, as usual, to balance a range of competing objectives such as fiscal discipline as well as job creation and a reasonable level of social assistance.
The Budget Numbers
For the 2011/12 fiscal year the Minister of Finance expects the budget balance to record a deficit of 4.8% of GDP. This is better than the 5.5% the Minister projected in October 2011. This will please the rating agencies, and should help South Africa avoid an outright ratings downgrade over the coming months.
The surge in the budget deficit over the past few years comes at a high cost.Government debt has risen from a low of 27.2% of GDP in 2008/09 to 36.0% of GDP in 2010/11 and is projected to rise to 41.0% of GDP in 2012/2013. This is the largest debt level, as a ratio of GDP, that South Africa has experienced since 2001/2002.
Key areas of growth in government spending during 2012/2013 remain education, health, housing and community development, public order and safety. The Minister also announced an increased focus on infrastructural activity, with Transnet at the centre of the strategy. Transnet is expected to spend R300bn over the next 7 years.
Total government revenue is budgeted to increase by a relatively modest 9.0% in fiscal 2012/2013, which seems realistic given the downward revision to the 2012 growth forecasts. In addition, the composition of tax revenue is not expected to change significantly over the coming year, with the bulk of the revenue still being derived from direct taxes in the form of personal income tax (36% of total) and company tax (21% of total).
Indirect taxes, such as VAT and the fuel levy, have grown steadily over the years and now comprise an indispensable component of tax revenue. In fact, the revenue received from VAT (26.2% of total) consistently and significantly exceeds corporate tax receipts, with 2012/2013 not expected to be an exception.
The Minister announced a number of tax changes in the budget. The largest tax change was an adjustment to the thresholds and tax brackets applicable to individual income tax. This is really to alleviate some of the effects of inflation, or what is referred to as ‘fiscal drag’. The value of this adjustment is R9.5 billion, which is enough to compensate for the effects of inflation or fiscal drag; and above the R8.1 billion tax relief that was granted to individuals in last year’s budget.
The Minister left the top marginal tax rate of 40% unchanged, although the threshold at which this is reached was increased modestly from above R580 000 to above R617 000 (a rise of 6.4%, which is broadly in-line with inflation). The change in threshold/brackets means that someone earning R100 000 a year will get annual tax relief of R685, while someone earning R1 000 000 will get tax relief of R4 795 a year.
The budget included a shock 20c/l increase in the fuel levy as well as an 8c/l increase in the fuel price for the road accident fund. The increase in the fuel levy is expected to raise an additional R4.5 billion in revenue. Unfortunately, South Africa is currently also experiencing a significant daily under recovery on the domestic petrol price of around 34c/l. This means that at the beginning of March the local petrol price could rise by a further, 53c/l, taking the price of 95 Octane in Johannesburg to another record high of R11.48c/l. This will negatively impact inflation as well as consumer activity.
The Minister also announced the customary increase in excise duties, which is projected to provide the government with an additional R1.84 billion in revenue.
Other tax changes included the introduction of the long-expected withholding tax on dividends (levied at 15%, and not the expected 10%), and a rise in the capital gains tax. On the plus side, the individual is encouraged to save more through a proposed adjustment to retirement taxes. To see comments by our tax expert, Michael Smythe, click here.
Overall, although the Minister provided some tax relief to individuals in order to compensate for the effects of fiscal drag, this was mostly offset by the increase in the fuel levy as well as the excise duties. Correspondingly, this was not an especially consumer friendly budget, which ultimately reflects the need for the Minister to contain the budget deficit.
Overall, the budget does a good job in meeting a broad range of competing demands. The Minister has managed to reflect a focus on fiscal discipline, but still provide a stimulus to the economy in the form of increased infrastructural spending. Of course, the government itself is not really embarking on an expanded infrastructural program; rather this is being conducted mainly through Transnet and Eskom. Nevertheless, the upgrading of South Africa’s energy, rail and port infrastructure is vital to our economic success; and long overdue.
The road to restoring fiscal discipline will not be easy. In particular, the government is likely to struggle to contain the overall increase in their wage bill. In addition, the growth in tax revenue will only be achieved if there is a reasonable pick-up in economic growth.
Lastly, while South Africa’s public sector debt parameters remain very acceptable by world standards, the total debt as well as the cost of servicing that debt is clearly on the rise. If left unchecked, government debt will quickly become a major hindrance to achieving many vital policy objectives. Already the cost of debt exceeds the total budget allocation to police services. Hence the Minister’s decision to focus on maintaining fiscal discipline, despite difficult circumstances, has to be applauded.
Fund overview and positioning
Global prospects have started to improve over the last few weeks, as the ECB provided liquidity to the European banking system and the outlook for the US economy improved. On the back of this the prospects for the equity market have improved. Within our funds, we are overweight offshore equities and underweight local equities. Given the current attractive valuations and positive growth story we will look to add to equities opportunistically. Our view remains that we want low cash holdings, given the negative real yield offered and favour inflation-linked bonds as a hedge to rising inflation, which is now more likely given the various budget announcements. We have also recently added to our global property exposure as it offers much more attractive yields than global bonds or cash.