Economic reaction
- Relative to the 2023 Budget, the Medium-Term Budget Policy Statement (MTBPS) indicates that the fiscal framework is challenged by poor revenue performance and swelling expenditure pressures from the public sector wage increases, rising debt service costs, and the further one-year extension of the Covid-19 Social Relief of Distress (SRD) grant. Meanwhile, government confronts large debt redemptions.
- Gross tax revenue is projected to undershoot the 2023 Budget expectation by R56.8 billion in 2023/24, relative to our estimate of R54.8 billion. A parallel shift is envisaged in the outer years (2024/25 to 2025/26), reflecting a weak starting point, and subdued economic growth. Main budget revenue has been revised lower by R44.4 billion; meanwhile, main budget expenditure is pushed higher by R10.3 billion, with higher debt service costs outweighing mild net reductions in non-interest expenditure.
- As a result, the fiscal deficit is wider at R330.1 billion (or 4.7% of GDP) for 2023/24, relative to R275.4 billion (3.9% of GDP) projected during the 2023 Budget. This, together with already committed Eskom debt relief of R254 billion and large debt redemptions, is expected to push government gross debt to 74.7% of GDP in 2023/24 compared to 72.2% at the time of the 2023 Budget. With a weak fiscal framework over the medium term, gross debt still stabilises in 2025/26, but at 77.7% of GDP, higher than the 73.6% peak envisaged in February.
- Despite the overall deterioration in government fiscal position, the fiscal authority remains committed to the consolidation strategy, with non-interest expenditure growing below inflation over the medium term.
In a nutshell, as was generally expected, the 2023 MTBPS has demonstrated a deterioration in the fiscal framework due to poor revenue performance amid reduced corporate profitability, particularly in the productive sectors of the economy, and cost-of-living pressures confronting consumers. This, along with expenditure pressures emanating from public sector wages, rapidly rising debt service costs and a further extension of the SRD grant, has materially weakened the fiscal framework relative to the 2023 Budget. Nevertheless, the primary fiscal balance is still expected to record a surplus from 2023/24 onward, and gross debt stabilises in 2025/26, albeit at a higher level.
In line with our expectations (see Economics Weekly), Treasury trimmed its economic growth forecast to 0.8% y/y (previously 0.9% y/y) for 2023. Due to ongoing weakness in external and domestic demand as well as infrastructure constraints, economic growth for 2024 and 2025 is lowered to 1.0% (1.5% previously) and 1.6% (1.8% previously), respectively. Growth is expected to reach 1.8% in 2026, underpinned by incremental improvements in infrastructure capacity. Inflation has been lifted to 6.0% in 2023 due to a weak exchange rate, but unchanged at 4.9% in 2024 and is expected to gradually moderate to 4.6% in 2025, reaching 4.5% by 2026.
Poor tax revenue underscores reduced corporate profitability
Total gross tax revenue is expected to grow by 2.6% in the current fiscal year, reflecting a material R56.8 billion underrun relative to 2023 Budget expectations. Over the two outer years, gross tax revenue is lower by R53.7 billion and R67.6 billion, with an average annual growth of 6.9% over the 2024 medium-term expenditure framework (MTEF, 2024/25 to 2026/27). Tax buoyancy is lowered to 0.61 (previously 1.06) for 2023/24 but normalises at around 1.09 over the MTEF.
- Generally, the in-year revenue underperformance mainly reflects poor Corporate Income Tax (CIT) revenue, down by 13.2% y/y YTD (April – September) and is expected to undershoot Treasury’s earlier expectations by a notable R35.8 billion. A reversal of revenue windfall from commodity prices, along with the cumulative impact of load-shedding and logistical constraints, has weighed heavily, particularly on mining sector profitability and tax contribution. YTD, the mining sector’s tax contribution is lower by R24.6 billion, followed by the manufacturing sector, which is lower by R3.8 billion, transport by R1.4 billion and the wholesale trade sector’s by R1.2 billion. On the other hand, tax revenue contribution from the finance sector is higher by R2.1 billion, assisted by sustained earnings amid a higher interest rate environment.
- Value Added Tax (VAT) revenue is also revised lower by around R25.6 billion in the current fiscal year, reflecting cost-of-living pressures that have weighed on household expenditure. But also, VAT refunds have increased faster (up by 14.3% YTD or R21.5 billion) due to exports and increased investment in embedded generation, as well as the higher cost of doing business, including the higher cost of road freight transportation away from rail.
- Despite the tax relief provided at the 2023 Budget, Personal Income Tax (PIT) revenue has performed decently, up by 7.9% YTD. It is expected to overshoot current fiscal year expectations slightly by around R6.4 billion. The continued PIT performance is mainly underpinned by a sustained recovery in earnings and higher bonus payments, particularly by the finance sector.
Expenditure adjustments reflect wage and debt service cost pressures
To contain non-interest expenditure and insulate the consolidation path, Treasury has made in-year expenditure adjustments, reducing non-interest expenditure by R3.7 billion. However, a rising debt service cost implies that total main budget expenditure (non-interest plus debt service cost) is revised higher by R10.3 billion. The following expenditure adjustments have been proposed:
- A R29.4 billion upward expenditure adjustment, of which R23.6 billion is allocated for higher public sector wage agreements towards labour-intensive departments, the outcome of which government did not want to pre-empt at the time of the 2023 Budget. A large portion of R17.6 billion of the wage increase allocation goes to the provincial departments and R6.0 billion to the National departments. Over the next two years, the public sector wage bill is expected to be higher by R19.7 billion, reaching R804.7 billion in 2026/27. These wage increases are assumed to grow below inflation at an annual rate of around 3.6% y/y over the 2024 MTEF. However, the risk is always tilted upwards for these projections.
- A R33.1 billion expenditure reduction, mainly comprising a R21.7 billion proposed reductions in baseline spending and a R4.6 billion drawdown in contingency reserves.
- Due to a widening fiscal deficit, higher short- and long-term interest rates, and a depreciated domestic currency, the debt service cost increases faster than initially expected. It (debt service costs) is up by 16.7% YTD and revised higher by R14.1 billion in 2023/24, R23.0 billion in 2024/25 and R28.4 billion in 2025/26. Expenditure on debt service cost is expected to reach 22.1% of revenue by 2026/27 (from 15.2% in 2019/20), maintaining its undesirable status as the largest expenditure item, and crowding out expenditure on critical economic infrastructure.
Risks to the fiscal framework and what to expect in the 2024 Budget Review
We concur with National Treasury that risks to the fiscal framework remain elevated. These include weaker-than-expected global and domestic economic growth, which would dent revenue growth and further widen the fiscal deficit; further bailouts from continued losses by municipalities and SOEs; and higher borrowing costs from elevated risk premium and tighter global monetary conditions. However, though not enough, government has set aside R27.1 billion in contingency reserves over the METF to cushion the fiscal framework from unexpected changes in economic conditions and unforeseeable spending pressures. Critically, to enforce the consolidation strategy and support growth, the following are to be outlined in the 2024 Budget Review:
- Proposal to scale down outdated and unproductive programmes and entities.
- A new mechanism will be created to crowd in financing from the private sector and international finance institutions for large infrastructure projects.
- New fiscal anchors to ensure a sustainable long-term path for the public finances.
- Tax measures will be proposed to raise additional revenue of R15 billion in 2024/25.
- Tax and expenditure measures to support the automotive sector during the transition to New Energy Vehicles.
Market implications reaction: Chantal Marx, Head of Investment Research at FNB Wealth and Investments
On balance, the MTBPS was more negative for equities than for bonds.
It was widely anticipated that revenue would fall short relative to Treasury’s expectations, that the stabilisation in government debt to GDP would be pushed out, and that non-interest expenditure rationalisation would be on the cards. It can therefore be argued that this was already “priced in”.
- Government’s commitment to its consolidation strategy (debt to GDP is still expected to stabilise in 2025/26, albeit at higher levels) and non-interest expenditure growth below inflation will be welcomed by bond investors. About two hours before the start of the speech, Treasury also announced that there will be no change in bond issuance post the MTBPS. The market reaction at the time was positive, with a net yield swing of ~20 bps on the ten-year bond yield following the announcement.
- This prudence, however, will likely be perceived as equity negative. Lower non-interest expenditure means that government contributes less to economic growth and that will have a knock-on impact on corporate revenue growth and by extension, profitability.
The guidance provided in terms of possible policy changes come the 2024/25 Budget in February will also be weighed by investors. Standing out to us in terms of the markets:
- Bond and equity investors will be encouraged by additional external financing of infrastructure projects as it will reduce government’s finance burden and will boost economic growth if implemented effectively.
- New tax measures to raise additional revenue will be regarded as more bond positive (higher government income) but will be equity negative (either lower consumer discretionary income or lower corporate profitability, or both) although the sum mentioned should not have too big an impact against an already cheap SA Inc basket.
As the minister spoke, the rand strengthened from about R18.70 to the US dollar to as low as R18.55, and bond yields fell across the curve. The JSE ticked up slightly, driven by an uptick in the SA Inc shares – largely explained by the rand and bond yield movements.
