Until South Africa gets its house in order from a sustainable economic growth perspective, every National Budget Speech will be of immense importance. Minister Tito Mboweni wasted no time this afternoon in highlighting (yet again) the undesirable state of the domestic economy and how that continues to weigh negatively on the Fiscus.

Economic Growth:

He still expects South Africa’s economic growth to come in at of 0.7% in for 2018 as many of the risks that the government warned about during October’s Medium Term Budget Policy Statement (MTBPS) have materialised. For 2019, Minister Mboweni expects a slower but steady economic recovery, following the previous year’s technical recession. He expects gross domestic product (GDP) rising to 1.5% in 2019 and then strengthening moderately to 2.1% in 2021.

Revenue Collections:

For the 2019 fiscal year, tax revenue has been revised down by R15.4 billion compared to the October estimate and approximately half of the increase in this shortfall is due to higher than expected VAT refunds. With regards to the credibility challenges that the South African Revenue Service (SARS) faced in the recent past, SARS still has no new Commissioner but Minister Mboweni says that a suitable candidate will be appointed in the next coming weeks.

In a bid to boost revenues, a review of duty free shops inside South Africa is underway. The Minister has also announced proposals for additional revenue measures of R15 billion in 2019/20 through a slight upward adjustment of the tax-free threshold for personal income taxes but with no change in the current personal income tax brackets. Together these are expected to raise R12.8 billion.

s per usual, increases in excise duties on alcohol and tobacco (sin taxes) will also offer the government an additional source of revenue as will a higher Road Accident Fund (RAF) levy. However, Minister Mboweni warns that the RAF increase is insufficient to match its R215 billion liability as such, he has urged the Department of Transport to quickly resubmit the Road Accident Benefit Scheme Bill for Parliament’s urgent consideration.

Still, the increases in fuel taxes together with the carbon tax on fuel is expected to raise R1.3 billion and increases in alcohol and tobacco excise duties will raise revenue of R1 billion.

An introduction of an export tax on scrap metal meanwhile, has also been identified as another potential source of revenue and to this end, National Treasury will work with the Department of Trade and Industry and the Department of Economic Development to explore this tax.

Tax Hikes:

With regards to taxes, the Minister was never widely expected to hike these as the country is already counted amongst the countries with relatively high tax rates. Therefore no changes are being made to personal income tax brackets but the tax-free threshold increases from R78 150 to R79 000. The government says their decision not to adjust the personal income tax brackets for inflation, will potentially raise R12.8 billion.

Spending Pressures:

Every year, the government always attempts to reduce expenditure and since the 2018 Medium Term Budget Policy Statement (MTBPS), it has taken steps to adjust this downwards by a total of R50.3 billion over the medium term. Nevertheless, the expenditure ceiling has still been revised upwards by R16 billion over the next three years.
Not only that, in this coming year government spending is seen at R1.83 trillion against revenue collections of R1.58 trillion, meaning the state will spend R243 billion more than it earns. According to Minister Mboweni, this results in a borrowing of about R1.2 billion a day and that the expenditure and tax adjustments are designed to largely counteract the additional allocation for Eskom and the revenue shortfall.

Budget Deficit:

The consolidated budget deficit is projected to narrow from 4.5% of GDP in 2019/20 to 4% in 2021/22. Gross debt meanwhile is seen stabilising at 60.2% of GDP in 2023/24.

Eskom Support:

As the government continues to acknowledge, State Owned Enterprise (The SOEs) still pose very serious risks to South Africa’s fiscal framework. In line with this year’s State of the Nation Address (SONA), Minister Mboweni is setting aside R23 billion a year to financially support the embattled power utility as it restructures its operations. However, Minister Mboweni is quick to reassure that this does not mean that the national government is taking on Eskom’s debt as pouring money directly into the parastatal in its current form, would be like pouring water into a sieve. Eskom’s fiscal support is conditional on an independent Chief Reorganisation Officer (CRO) being jointly appointed by the Ministers of Finance and Public Enterprises with the explicit mandate of delivering on the recommendations of the Presidential Task Team.

As for the other SOEs, the government is reviewing its framework for their support but has nonetheless revised the contingency reserve upwards to R13 billion for 2019/20 (during this past financial year, total guarantee utilisation increased by R51.1 billion). The upward revision of the contingency reserve for SOEs is to respond to possible requests for financial support, as Minister Mboweni puts it.

All in all, this year’s National Budget Speech is built on the following six fundamental prescripts:

  1. Achieving a higher rate of economic growth
  2. Increasing tax collection
  3. Reasonable, affordable expenditure
  4. Stabilising and reducing debt
  5. Reconfiguring state-owned enterprises
  6. Managing the public sector wage bill

Market Reaction:

The South African rand (ZAR) slipped from levels around 14 USDZAR this morning to levels around 14.15 USDZAR at noon before stabilising just below this level in anticipation of the Minister’s National Budget Speech for 2019.

The South African 10-Year benchmark yield was muted leading up to the budget release - rising by a mere 5 basis points; whilst large rand-hedged counters on the JSE benefited from the weakening of the rand with the All-Share index up over 500 points just before the speech.

Immediately after the Minister started delivering the budget speech, there was excess volatility in the bond and currency markets while listed equities continued their steady positive run for the day. The 2030 yield rose a further 24 basis points to trade around 9.68% from 9.44% at the start of the speech, whilst the rand weakened to levels in excess of 14.30 USDZAR before both started moderating back down, currently trading at around 9.41% and 14.14 USDZAR respectively (14:55).

Moody’s, who are the only major credit ratings agency which continues to rate South African government bonds at investment grade, has previously warned the South African government over threats to a downgrade to “junk” status. These threats stem from anaemic economic growth, high levels of government debt and policy uncertainty.

Economic development was allocated two hundred and nine billion rands, which is a 4.5% increase from last year’s allocation. However, given the current budget deficit coupled with additional allocations to Eskom, no inflationary relief was given to consumers on their personal income tax. This is likely to provide some headwinds for the economy given that final household consumption expenditure is more than 60% of GDP. Whilst the maintenance of the government’s outlook on their debt-to-GDP ratio is likely to ease some pressure on South Africa’s credit rating.

Investment Message:

From an investment strategy perspective, we continue to favour government bonds; room for yield compression, attractive coupon rates, a stable risk/return profile and an alternative beta to the listed equities market, which has proven itself in protecting our portfolios from massive drawdowns during periods of heightened market volatility justify a significant holding of this asset class in our portfolios.

On listed equities, notwithstanding that the market remains about 7% cheap according to our valuation models; we remain neutral on this asset class. Anaemic economic activity, low corporate profitability, high levels of volatility and weak investor sentiment point towards a cautious but positive allocation to listed equities.

Within listed equities, we continue to favour large-rand hedged counters which will benefit from a moderate weakening of the South African rand against major developed currencies broadly in-line with the respective government bond yields.