Nene on a tightrope with a hat losing rabbits

WITH just four weeks to go until Finance Minister Nhlanhla Nene tables his mediumterm budget policy statement in Parliament, he will be looking into the hat to find the proverbial rabbit.

Last time, the rabbit came in the form of a few billion rand of unexpected revenue from changes to the tax on share incentive schemes. This time the rabbit is a non-incentive of sorts, in the form of a R15bn Unemployment Insurance Fund (UIF) concession that wasn’t.

The February budget included the concession — a one-year cut in UIF contributions that would have put money “back into the pockets of workers and businesses”, in part as a sweetener to counter the one percentage point hike in the personal income tax rate. As it turned out, the politics and practicalities were a little complex, so it was not implemented.

But the R15bn, which HSBC economist David Faulkner notes is equivalent to about 0.4% of gross domestic product (GDP), should provide enough room to enable Nene to meet his 3.9% consolidated deficit target even if revenue falls short because of an economy that is looking much weaker than expected.

That’s the consolidated budget balance, which includes the balances of social security funds such as the UIF. But it will be worth keeping an eye on the main budget balance, which could be worse than the expected 4.1% deficit, though again, the hat might contain the odd rabbit — Faulkner (who was once at the Treasury himself) points to extra cash balances as a result of last year’s revenue overruns, for example.

The question, however, is how long Nene can carry on pulling rabbits out of hats, as SA’s finance ministers have been wont to do when times get tough and revenue runs under. This is the medium-term budget. And the core risk to the fiscal framework is that the growth outlook, not just this year, but in the medium term, looks bleak. That will make Nene’s growth projections on October 21 very important.

With question marks over credit ratings following downgrades to peer countries such as Brazil, updating SA’s growth forecasts will be a delicate balancing act. The Treasury needs to be realistic — growth forecasts that are too high would yield unattainable revenue forecasts and fail to convince the market at a time when ensuring a credible budget is crucial to keep rating agencies and markets on board. Yet too bleak a forecast could be a very negative signal, which itself could spook investors and agencies.

It is one thing for private sector economists to slash their forecasts — and they are doing just that, cutting to less than 1.5% this year and not much more than that next year after the second quarter’s contraction, and the question marks over global growth.

It is quite another thing for official forecasters to downgrade. But Nene is clearly going to have to cut his February forecast of 2% for the current fiscal year, rising to 3% in 2017-18. It’s the outlook for the latter years that is arguably of more concern. The fiscal consolidation plan to which the government is committed relies on growth picking up later, and assuming the government sticks to its spending ceiling, revenue is supposed to improve, the deficit to start coming down and the debt ratio to peak before coming down three years out.

It’s particularly important for the plan that the economy, and tax collections, do pick up towards 2017-18 because there is a “bubble” of government debt repayments due around then. But what if growth doesn’t pick up to 3%, or even 2%?

The risk is made greater because Nene has lost the R65bn cushion of “unallocated reserves” that he had provided over the next three years to the public service pay deal, which could add that and more to the personnel budget he provided in February. So he doesn’t have a lot of flexibility to deal with revenue shortfalls. Those are more than likely, especially given the scary stuff coming out of international research houses.

Citi’s Gina Schoeman points out that the US bank now puts a 55% probability on what it calls a global “recession” next year — where the global economy falls behind its poten- tial growth rate of about 3% and delivers “something with a 2%”. If that’s grim, the predictions of Annelise Peers of Investec’s Swiss-based wealth and asset management business are even worse — she talks about a commodities cycle that could bump along the bottom for another 10-15 years, and a global economy that could head into recession by about 2017.

Chances are that something has to give, if not now, then soon. There is already a cap on government spending growth; actual austerity-type cuts are politically unlikely. That leaves revenue, which has already been augmented by February’s personal income tax and fuel tax increases but will surely need more.

The Davis committee has recommended that a value-added tax (VAT) increase would raise the most revenue with the least economic damage. A two percentage points increase in the VAT rate, for example, would replace many rabbits, cutting a whole percentage point of GDP off the budget deficit. In the medium term, a VAT rate increase must be inevitable. The question is how Nene will handle the controversial politics of it.