What to look out for in the budget now the boom is over

Over the past two to three fiscal years SA benefited from a surge in commodity prices as the global economy recovered from the effects of the Covid pandemic. The cycle has turned, and the revenue windfall from commodities is past for the National Treasury, which now faces considerable spending challenges, including the potential of higher-than-expected public service wages and requests for additional funding from financially distressed stateowned enterprises.

Given high unemployment and poverty rates, the social wage will continue to exert upward pressure on the budget and put fiscal reduction efforts at risk. Over the next three years it will account for more than 60% of all noninterest spending. The social wage, with the contingent liabilities to distressed state-owned firms such as Eskom and Transnet, as well as the public wage bill, will continue to pose the most significant threat to fiscal consolidation and debt stabilisation.

The expenditure challenges come against the backdrop of a precarious economic growth outlook. Long-term growth is expected to be constrained by factors such as power outages, inefficiencies in ports, failing rail and road infrastructure, high interest rates, growing borrowing costs and heightened geopolitical tensions.

The IMF has revised its prediction of 1.8% growth for the country this year to 1%, underperforming emergingmarket peers (4.1%) and other Sub-Saharan economies (3.8%).

It is under these conditions that finance minister Enoch Godongwana will deliver his third budget speech this week. When he delivered the medium-term budget policy statement in October, the expectation was that revenue collection would be R56.8bn below the 2023 budget estimate because of falling commodity prices, an increase in VAT refunds, a lacklustre domestic economic outlook and negative shifts in the global economy. The budget deficit is predicted to increase to 4.9% in the 2023/24 budget.

To fund and shrink a budget deficit, government can do the following: raise taxes, cut expenditure or borrow more. We expect no change to personal and business tax rates but an increase in sin taxes (alcohol, tobacco and sugar levies) and a slight increase in fuel and Road Accident Fund levies, given that these have not been adjusted in a while and the minister hinted at certain tax adjustments in October 2023. Should this materialise, it may hurt the pace and path of inflation deceleration and put a damper on deep interest rate cuts, expected to commence in the second half of the year.

With extremely limited fiscal margin to manoeuvre, a widening budget deficit and little room to hike taxes to a significant degree, government will need to cut spending and borrow from capital markets to bridge the gap. Debt has a cost, and government spending on debt servicing costs is soaring, crowding out spending on its priority programmes. In the medium-term budget, debt service costs as a percentage of main revenue were predicted to rise from 18.2% in 2022/23 to 22.1% in 2026/27. This implies that for every 100c of revenue generated 18c go towards debt repayment, which is likely to increase to 22c in the coming years.

Given the above fiscal prognosis, debt will spiral out of control if it is not addressed. To avoid this catastrophe the economy will need to grow faster than now predicted or government spending will have to be reduced.

GOVERNMENT CAN DO THE FOLLOWING: RAISE TAXES, CUT EXPENDITURE OR BORROW MORE

In the interim, government has few options but to borrow from capital markets. We thus anticipate an increase in government borrowing, and an increase in alternative types of borrowing, such as the issuance of sukuk bonds instead of nominal government bonds. We also expect government to widen its scope for concessional borrowing — borrowing at interest rates that are lower than market rates.

We expect the minister to reiterate government s commitment to fiscal’ consolidation through spending cuts. In an election year this may be a bridge too far, but we still expect some reprioritisation without sacrificing critical spending such as the social wage.

Over the medium term, government reconfiguration will be required, including the merger or closure of some public entities, which will result in a reduction in transfers to these bodies.

We do not expect a detailed announcement on these, which will most likely be deferred to the next administration after the general elections, which will probably take place late in the second quarter of the year.