Faced with lower-than-expected revenue growth, pressure to cut spending and a worsening fiscal deficit, finance minister Enoch Godongwana has his work cut out when he presents the medium term budget policy statement (MTBPS) on November 1. After three years of excessive revenue collection, boosted by higher corporate income tax on the back of a commodity boom, the government faces fiscal turbulence owing to a wider budget deficit and higher debt ratios.
The policy statement is expected to show a revenue shortfall of R31bn in 2023/24 and an expenditure overshoot of R56bn. With a baseline budget deficit of R363bn, the government will need to tap into all its funding sources to finance the larger deficit. But the spiral of the debt-to-GDP ratio, which rises to 78% by 2026/27, is clearly unsustainable.
As a result, the government may have to bite the bullet and consider additional tax measures to raise revenue to fund a basic income grant. Ordinarily, given the tight fiscal space, spending should be curtailed until economic growth accelerates. However, it is difficult to see total spending declining in real terms without large-scale job losses in the public sector ahead of a national election, a time in which employment typically increases.
The post-fiscal period of strong tax revenue overshoots has proven to be fleeting, driven by a decline in commodity prices and higher operational costs impeding corporate profitability. With weak growth and inflation expected to decline over the medium term expenditure framework (MTEF), nominal GDP growth is unlikely to support a fiscal turnaround. Unless the country experiences strong growth, aided by another commodity boom or substantive structural improvements, South Africa's fiscus is expected to deteriorate rapidly, particularly if expenditures are not restrained.
While our estimates point to much larger deficits and a steady increase in the debt-to-GDP ratio over the MTEF, the risk is to the downside — we could see even worse fiscal outcomes due to rising state-owned enterprise (SOE) bailout demand, social spending constraining capital investments and lower revenue collection growth.
We have been quite conservative in projecting GDP growth, and we maintain a weak growth outlook, primarily driven by below-trend growth in most of South Africa's main trading partners and weaker investment growth after the high base effect from the past two years. Nonetheless, even though our real GDP growth estimate rises over the MTEF off a low base from the current year, it still is below the National Treasury's forecast at the time of the February Budget Review.
We estimate nominal GDP growth of 5.2% in 2023/24, marginally below the Treasury's 5.3% — this divergence is estimated to grow to 80 bps by 2025/26 when we anticipate nominal GDP growth of 5.7%.
Therefore, a downward revision to growth forecasts will likely be made when Godongwana presents the MTBPS. We expect both headline CPI and GDP inflation to decline over the MTEF, closer to the Reserve Bank's inflation target of 4.5%. The lower inflation trajectory, however, also constrains nominal GDP growth.
While customs duties and personal income tax collections are expected to be revised marginally higher, as tax collection has exceeded February estimates, corporate income tax collection is expected to fall sharply in 2023/24, while VAT collection will also disappoint. An estimated shortfall of R36bn is expected this year in corporate income tax, while VAT collection is likely to be revised R12bn lower amid weak consumer demand. Upward revisions from higher personal income tax collections and customs duties may offset this shortfall somewhat, providing a net revenue shortfall relative to the Treasury's estimate of R31bn.
This implies tax revenue growth of 3.8% year-on-year in 2023/24, relative to the Treasury's estimates of 6% made in February 2023. Still, the risk to this forecast is to the downside. While revenue collection is set to disappoint this year, it is still tracking above the pre-pandemic average across all the major tax categories. Revenue collection between April and August this year was 66% higher than the historical average, while corporate income tax collection was 79% higher. However, this has been offset by expenditures, which are 74% higher than the pre-pandemic average, resulting in the recent fiscal slippage.
On government debt, the Treasury's debt stabilisation is still elusive, and the budget deficit is moving in the wrong direction. In the absence of structurally higher growth, the Treasury's highly optimistic deficit profile is unlikely to materialise. Our estimates point to a smaller nominal GDP, suggesting the fiscal ratios are likely to be worse than our previous estimates.
Our estimate of the consolidated budget deficit remains above the Treasury's forecast over the MTEF at 5.2% of GDP in 2023/24, rising to 5.6% by 2025/26, and is estimated to widen further to 5.9% by 2026/27. Consequently, the debt profile will likely rise from 74.3% of GDP in 2023/24 to 77.8% by 2026/27. The deficit projections exclude the possible expensing of the Eskom bailout of R254bn over the forecast period. The Treasury has indicated that the Eskom loan (or bailout) will be a debt-for-debt transaction and, therefore, deficit-neutral. If not, our baseline deficit as a percentage of GDP forecasts may be 100 bps higher.
The February 2023 Budget Review represents a best-case outcome, due to a few unrealistic assumptions. Among them were an end to the social relief of distress grant two months before the national election, a wage bill growth rate of 1.6% this year, a real decline in total expenditure, higher tax revenues off a very high base and nominal GDP rising at a brisk pace over the MTEF, in contrast to the Bank's efforts to reduce inflation, and structurally weak real growth evident.
We estimate a revenue shortfall of R170bn over the next three years and R31bn in the current year. The revenue shortfall, relative to the February Budget Review estimates, widens over the MTEF. Spending revisions in our base case amount to R234bn higher over the next three years. In a bear case where real GDP growth remains below 1% until 2026/27, this revenue shortfall could widen to R225bn on a three-year basis.
The Treasury will need to take tough decisions to stabilise government finances. The projected revenue undershoots, combined with an expenditure overshoot, imply a larger financing requirement, which needs to be funded using a combination of debt instruments (nominal bonds, ILBs, floating rate notes, short-term debt, foreign loans) and cash. However, since demand for bonds, in general, has been lacklustre, this could threaten the Treasury's ability to tap into the diversity of its funding mix. As a result, all financing tools will need to be used to fund the deficit.
Sumad is senior research analyst, Nedbank Corporate and Investment Banking
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