Head of interest rate process at Futuregrowth, Wikus Furstenberg, has been crunching the numbers Finance Minister Pravin Gordhan has to work with ahead of Wednesday’s Budget. In this interview with Biznews.com’s Alec Hogg, he explains what the reappointed Finance Minister will need to table to show the re-engaged business community he can deliver on what is being promised. Read no increase in corporate tax, concrete evidence of expanding Public Private Partnerships; a more stringent approach to State Owned Enterprises – and, to provide his fiscal conservatism, an increase in VAT.
This special report is brought to you by Futuregrowth and Wikus Furstenberg, who’s Portfolio Manager and Head of the Interest Rate process at Futuregrowth joins us now. At a time when people are battling to understand the Rand volatility and the movements in interest rates Wikus, we’ve got the Budget coming up this week. How important is that going to be in the way that interest rates go forward and indeed, the exchange rate?
Alec, it’s crucial. What the market as a whole is hoping for is commitment from Government to fiscal consolidation. There’s nothing new in that and we’ve heard many promises in the past. It’s not just in the last week. Really, now is the time for them to deliver on that as well. I think there are probably two things that the market will be looking for: (1) exponential seeding. Please don’t exceed it. In fact, if any, we’d like you to cut expenditure. (2) The end result that we would like to see is some debt stability – a proportion of total Government debt – of GDP and that needs to come down. If you include those contingencies, the explicit Government guarantees to state-owned enterprises, etcetera…we’re already sitting at just south of 60 percent. It’s simply too high. We can’t afford that.
So there are quite a few signals that we need to watch out for.
Definitely. What worries me a little bit is that a lot of noise has been made since the fiasco in December – the ‘do not worry. We will deliver and we will make good’ – and I think there’s some expectation in the market already that this is going to be a good Budget from a market perspective. Again, with the emphasis on consolidation. Obviously, what makes it very difficult for the Ministers is to find that balance between consolidation and the issues around growth, and profound weakness of growth is obviously a major problem that cannot be fixed quickly. You referred to the currency earlier on. I think that some of the issues around the currency relates to not just global growth, but also local growth and it’s going to be a difficult one this time around.
We’ve seen the currency pick up in the last few days, though. Is there anything that we can read into that?
I think you mentioned the difficult around getting the currency right. I think the first thing is that we have to acknowledge that globally, the Dollar has lost some ground. One of the reasons the Rand was so weak amongst other emerging market currencies is Dollar strength globally, right? It’s simply because the Fed is the first major central bank that’s in position to actually start normalising rates and relative stronger growth when the U.S. supports the Dollar – that’s the first thing. What we saw a little last week was some concern about growth momentum in the United States. The Dollar’s lost a bit of ground and obviously, that will help the currency but then in the second phase there’s this expectation that we refer to locally, which is ‘all eyes are on what Government is going to deliver in terms of this promise of fiscal consolidation and how exactly they’re going to get to that’.
The thing that worries me a bit is that there’s already some expectation going back into the market. Having said that, it’s always important to keep perspective. We need to go back to see where the Rand and local bonds were trading before we had that fiasco in December. We still have some way to go to recover some lost grounds so maybe we should just keep that in mind as well.
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Yes. Bonds were around 830. They’re still at nine – almost 100 basis points higher than what you referred to as ‘the fiasco’. How long will it take to get that out of the system – get Nenegate (as we call it) behind us?
I like to look at it in two ways. (1) You have the monetary authorities on the one hand and of course, the fiscus on the other. In terms of the South African Reserve Bank, we’re very happy with what they’ve been doing and the reason why they’ve been doing what they did. The increase in the repo rate recently was done for the right reasons. We need to manage inflation expectations – they only tool that they have – and the hard way to do that is to use interest rates. We’re fairly comfortable with that pillar in terms of policy credibility. On the fiscal side, we already made some sound announcements. The first thing was the appointment of Mr Gordhan for the second time. That was a quick recovery. There’s a silver lining in that. The second thing was that immediately after that was the commitment to do what is right. It’s nice to hear that.
At least, there’s some acknowledgement. We’ve all heard that now. What’s been happening with the SAA thing also helped in late December, where [inaudible 0:05:46.4] said, “We’re not going back. We’re sticking to that initial agreement with Airbus.” That was a good one. Next week is important so see a lower Budget Deficit. That’s what we’re hoping for – a three percent Budget Deficit as a percentage of GDP for 16/17 as opposed to something closer to four. That’s going to require them to cut expenditure but also, to raise taxes I’m afraid to say. Then Alec, to really recover…the proof is still in the pudding. We’ve been here before so it’s going to take a few months for that credibility to recover on a more sustainable basis. You’re going to see short-term reactions from the market – relief rallies and all that – but at the end of the day (and that’s going to take months)…
October is probably the next target and then February next year because we cannot – again – stiff on the commitment to consolidation. We cannot do that. That commitment needs to be backed by realistic assumptions as well. We cannot again, say growth is going to grow for instance, – this and next year – at two and three percent. It’s not going to be that high. They have to acknowledge that and that is very important because if any of these are based on unrealistic assumptions in terms of the macro backdrop then that credibility will not recover.
So acknowledge reality, as bad as it might be.
Yes. It’s not about October, February, or December last year. It’s about what happened the last three years. There’s been persistent slippage and it’s crept into the number, and we need to consolidate. We cannot continue like this anymore. That’s the one thing. The thing that worries me more – obviously, we heard the ratings agencies. In my mind, they’re still backward-looking – but nonetheless there’s this concern about growth. You cannot expect the Minister to fix our growth problems in one Budget speech. It’s not going to happen. It’s a process and it’s going to take a long time.1 It’s a difficult thing to do and it’s something that has been neglected for a number of years now. I’m not convinced that a good budget will necessarily prevent an investment downgrade in few months’ time.
Wikus, what can be done? To your point there, the ratings agencies are now looking for higher growth and fiscal discipline.1 Pravin Gordhan can give them the fiscal discipline – one presumes -, given that the President is now supporting him but as you say, he cannot switch on the growth engine or the growth tap. As a consequence, you almost have to ask yourself, “Well, we’re going to junk status. Why bother?”
I think it’s all about debt stability and the sustainability of the debt holding that we have. Just to put that into perspective, if you compare us to a sample size of about 42 countries, we don’t look that bad at all. That’s not the point, though. The point is that it’s getting more expensive to service the debt and it’s going to become increasingly difficult to do that if we don’t consolidate that now. We should not just be focused on what ratings agencies may or may not do. Keep in mind that we only received an investment grade for the first time somewhere in February 2000, from S&P. We were running sub-investment ratings before. My issue is that we need to do the right thing for the right reasons. We’re all jumping up and down (including Government) about this risk from ratings agencies but the focus really should be what we should be doing locally to get things right.
The first thing that we need to do is to manage the costs of servicing that debt of ours because at the end of the day, what happens there is you take away from somewhere else to service this debt and that’s something we cannot afford. We can ill-afford that. That’s what Trevor Manuel and his team managed to do very well in the good old, early 2000’s when we were in a similar position in terms of these things and they gradually ground the deficit to lower levels and in the process, funded less. Eventually, they got into the position where they actually bought back debt and they did that because they wanted to free up some cash for social and infrastructure spending. That’s what we need.
That’s a sensible way of doing things and as you say, we’ve had slippage over the past three years, which means we’re back in that mode or that way of thinking. You did mention that you expect there to be tax hikes in the Budget and some cuts in Government spending. Could you be a little more specific? Where do you see the tax hikes coming and indeed, where do you see scope to cut back on state expenditure?
I’m going to start with the difficult one because we simply don’t have all the information, do we? On the expenditure side, it sounds harsh and it’s probably unrealistic but you need to do something about that wage bill. It’s just taking up too much. It’s going to be very difficult to do and they’re probably going to cut back on some infrastructure spending for now as well. You cannot cut back on social grants. Anyone who promotes that is foolish because it’s something we cannot afford to do at this point in time, and so you need to look elsewhere. All I know is that we’ve done the numbers and to get to a budget deficit of around three percent, which I think the market would be [sort of] happy with for now, they need to cut expenditure by X and they need to look at that wage bill of theirs1. That’s on the expenditure side. On the revenue side, it’s probably a little easier.
There are a number of things, which they could do. Given the Gini coefficient that we’re battling with in South Africa, the big spread between high and low income earners… Personal income taxes for the upper income earners I’m afraid to say, is relatively easy to get away with that. Obviously, you need to be sensitive to how much you do. I don’t think you should do more than one percent but something needs to be done in terms of that. The Capital Gains Tax thing, Dividend Tax, Estate Duties, and Syntaxes. The Fuel Levy. Remember what happened last year? The petrol price was lower. It gives them some sort of leeway there to do something. There are quite a few analysts out there who are also thinking that maybe we should just do something about that. That was obviously a consideration. Whether they’re going to have the stomach to do that is obviously a different story.
We’ve looked at numbers and what we would like to see… We don’t have to do that rate hike now. We would be able to get away with higher tax by addressing those factors I mentioned. From a bump market perspective, that hike will be very bond-friendly simply because it’s easier to do and you can guarantee on that tax revenue coming through.
If you have your back against the wall from the ratings agencies’ perspective and you want to try and keep your costs of borrowing down, the way to do it is to increase VAT. That’s the easiest way of doing it. Alternatively, you can fiddle with a number of things. As you say, Capital Gains, Top Income, and the Fuel Levy, (which already went up 80 cents last year). You wonder how much scope there still is to take that one up, but I’m sure they’ll find it – Dividend Tax, Estate Duty etcetera. The easy way economically, would be VAT but that’s very difficult politically.
I think it’s very difficult politically, unless you use programs like National Health Insurance as an excuse to do that. That would be ‘first prize’ if we could do something about the VAT. We will probably find a combo between the ones I’ve mentioned and then maybe a smaller VAT hike. I don’t know whether it’s too late for them to look at that now. Maybe it’s something for next year.
With Pravin Gordhan apparently in a very strong position, if ever a VAT hike was going to be palatable, now might be the time.
Well, you can certainly make a case for that, Alec. He is in a strong position. You can only imagine what had happened in December before his appointment was announced. It certainly would help. I think it will add to anti-policy credibility as well. You’re prepared to do that in a year where you’re [inaudible 0:16:00.0] municipal elections where you as the ANC, don’t feel too comfortable about the potential outcome in certain districts. It certainly would assist in terms of that policy credibility because that is one of the strengths, which we have. If we compare us with Brazil for instance, Brazil is just nowhere in terms of policy credibility – absolutely nowhere and that was one of our relative strengths. If we can regain that, it will certainly help a lot.
The big story when looking at the Budget is policy credibility. The way that one could enhance that would be by increasing the VAT rate. Whether that’s politically palatable, we will only know then. Is there any upside though, in all of this? South Africans are desperately trying to find hope somewhere. Can you give us some guidance?
Let’s be realistic. That commitment to fiscal consolidation coming from the Minister next week: in my mind, that’s good news because we’re going back to what we said before. Obviously, what Government needs to do (and they’ve talked a lot about this)… I don’t know whether we’re going to add any value by repeating this – the so-called new openness to a public/private partnership. For instance, in particular for infrastructure development. A new, more stringent approach to SOE’s is very important. We know what’s happening in some of those bigger SOE’s. They need to follow through on that promise and then of course, the privatisation thing. I don’t want to make too much of the privatisation thing because for now, I don’t think that’s realistic. You also cannot ignore the labour units. That will be silly. You can’t do that.
There’s always those risks where you make all of these promises, but they end up being unrealistic and you’re unable to deliver. The word ‘deliver’ brings me to the next point. Now is the time to deliver and I think they need to communicate to us as well in terms of progress that delivery of all these subjectives. It’s very important. We can’t wait for the table. We want to see consistent communication in terms of that.
From a business perspective, once Pravin Gordhan has spoken on the 24th; if you were to take the most realistic changes that would delight business rather than perhaps those which they would pray for – just the realistic ones -, what would be the messages? What would be the signals we should look for?
The first thing is that we don’t see an increase in corporate tax rates. There’s an acknowledgement time are difficult so we’re not going to do that and that’s why I haven’t listed that as a potential source of more tax revenue. Again, we may go back to that follow-through on recent meetings with CEO’s opening the gates to discuss these things, and go out and see what we can get from business in terms of helping us to solve our problems. Let’s work together. We need to get labour into that negotiation as well. I forgot to mention this whole nuclear energy thing as well. I know what the Minister said. He said, “Don’t worry. We will look at what we can afford.” We also need to remember that again. Is what we’re going to be doing, the right thing? We cannot afford that at this point. Going forward, we will do a proper analysis of what can be afforded.
The carbon tax will have a serious negative impact on the goods-producing sectors of the economy, particularly mining, manufacturing and agri-processing by making the country less competitive in the global economy.
Econometrix submitted a report on the 2013 update to the Integrated Resource Plan (IRP) for Electricity, IRP 2010 to 2030.
We have updated the report and it spells out the damage the carbon tax would do to the local economy. Included in the report is comment on the futility of introducing a carbon tax or any other envisioned carbon tax-trading scheme.
The exception to this has been the US, where greater use of gas has led to a slowdown in their growth in carbon emissions.
The annual growth increase of China’s carbon emissions has been 520 million tons a year over a ten-year period compared to South Africa’s total annual carbon emissions of 440 million tons in 2013.
A saving of 20 percent in South Africa would amount to 88 million tons but India’s annual growth in carbon emissions over ten years exceeds 90 million tons a year.
Any decline in the growth of carbon emissions in China and India is unlikely in the period up to 2030 as they continue to pursue economic growth.
Furthermore, the argument regarding global warming has changed considerably over the pastfew years. The global temperature has not increased materially for more than 18 years.
Econometrix is not an expert in this field but it would appear that there are extremely strong arguments and indications that the impact of man-made global warming has been vastly exaggerated. Certainly, South Africa should not be leading the pack in curbing its own carbon emissions at substantial economic and personal cost when the rest of the world is flagrantly disregarding the same set of rules. This is particularly true when South Africa’s likely contribution to any reduction in carbon emissions will be less than measurable.
Passing on costs
A carbon tax will increase the costs of electricity and the products of many important industries. These costs will be passed on through price increases to business and consumers. Downstream business and industry will be faced with these increased costs and will in turn pass these costs on to its consumers.
Certain industries will be faced with a carbon tax of their own and in turn their increased electricity costs and carbon tax costs will also be passed on to their consumers and users of their product.
Ultimately, demand will decline as the price increases faced by consumers will reduce their disposable income. In the case of export industries trading in the global competitive market they will either face a decline in demand and/or reduced prices with resulting lower returns. In turn, imports would become more competitive and import sensitive industries would suffer.
The complex impacts of unnecessary real price increases would result in a further deterioration in the current account of the balance of payments, already at an excessively high level.
Furthermore, there would be a decline in the return on investment of the affected business and real investment would decline. At present, it is already running at below required levels capable of sustaining an acceptable economic growth rate.
Each industry would need to be examined on its merits. An example of the damage it could cause would be the motor vehicle industry. Current exports total more than R100 billion an annum and total employment exceeds 100 000. The competitive damage to this industry alone could be significant.
Econometrix has calculated the economic impacts of these effects. The carbon tax would slow gross domestic product (GDP) growth by 0.4 percent a year, resulting in a 6.5 percent reduction in the size of GDP by 2030, or R350bn, and a reduction of almost 1.4 million in the number of jobs available.
The number of dependents affected is therefore estimated at almost 5 million. This is a sizeable effect on an economy with a population estimated to be approaching 70 million by 2030.
Significantly, it will reduce the cumulative taxes collected by 2030 by R750bn due to the slower growth. It will require a large and costly bureaucracy to run this complex, cumbersome and highly inefficient tax. The reduction in taxes is likely to be greater than the net taxes that will be collected.
The argument that the tax will be neutral because this money will be funnelled back to develop the green economy must be treated with great suspicion.
There are a number of economic arguments that strongly suggest that this will not be the case.
It amounts to a tax on existing industries and effectively a subsidy for new ventures many of which are less efficient with higher cost structures.
It consequently will foster higher costs and inflation. Bureaucracy is not the best means of fostering economic efficiency.
This is the task of market forces in order to develop a more efficient and effective economy. The experience overseas supports this argument. For example, there are substantial question marks regarding the policy and Germany’s “Energiewende” is a well-documented case in point.
Electricity prices there are the highest in Europe because of the move to renewables and that the development of the new transmission grid has fallen well behind schedule resulting in localised rolling power cuts and has required substantial unforeseen investment.
As a result, certain key electricity-intensive industries are considering moving to the US.
It is worth noting that Germany is in the process of building a number of coal-fired power stations to correct the imbalance that renewables have caused for electricity supply.
Finally, carbon tax and higher prices of the large input cost increases from electricity price increases runs contrary to the country’s own beneficiation policies, where some companies are now expanding elsewhere because of the non-competitive electricity costs in this country. It is noteworthy that one of South Africa’s key global competitors, Australia, has scrapped plans to introduce such a scheme.
Damage to potential
Econometrix has recently estimated that South Africa should, with the correct policies and adequate and secure electricity growth, have a potential sustainable growth rate of GDP of 4.1 percent a year.
As a result of a number of policy issues, insufficient security of supply and non-competitive prices of electricity, the carbon tax and the switch to more costly renewables and other investment adverse policies, the sustainable GDP growth of South Africa is unlikely to exceed 2.5 percent a year .
This will have a detrimental impact on the country’s goods producing industries, particularly mining, mining beneficiation, manufacturing and its agri-processing sectors.
By 2030, this would result in GDP being R1.4 trillion less than what should be achieved, while employment levels could be roughly 5 million lower than the levels actually possible and required.
Carbon tax will play a substantial role in this poor economic performance, which will have a detrimental effect on the standard of living, unemployment and the social and political structure of South Africa.
More particularly it would make the country’s important goods-producing sector less competitive.
This will cause further structural problems for the current account of the balance of payment, which already has a substantial deficit.
In the latest global competitiveness report, out of 144 countries, South Africa has fallen to 113th in terms of its labour market efficiency, 89th on its macroeconomic environment and has fallen 11 places to 56th in the overall competitiveness index.
The carbon tax will only exacerbate these trends. Most importantly it will more than likely result in a further deterioration in South Africa’s sovereign rating with serious consequences to South Africa’s cost of capital, ability to raise capital and its ability to attract foreign investment.
Rob Jeffrey, is the managing director and senior economist of Econometrix
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A tax is a compulsory contribution to state revenue, levied by the government on workers’ income and business profits, or added to the cost of some goods, services, and transactions. Money collected from taxes goes into the general fiscus. Comparatively, a waste management fee is paid by product producers and importers, and is used for dealing with the product when it reaches the end of its life cycle.
This money is directly and specifically applied to dealing with the product, in an audited and accountable fashion, making it far more effective than a tax-based system where funds sink into the general Treasury and are not ring fenced.
The way to get worth from waste is to turn it into something that people will pay money for, and the way to do that is to create a circular economy. Instead of making a product for consumers to throw away, we need to extend the life of the product beyond the consumer stage by recovering, recycling and reintroducing it into the economy.
Experience shows that where manufacturers are encouraged to regulate themselves, some do and some don’t. Some pay and some won’t. In Germany, 60% to 70% of tyre manufacturers at most pay an industry body to discharge their extended producer responsibility for them. Here in South Africa, the figure stands at 99.8%.
The difference is that in Germany, extended producer responsibility is voluntary; in South Africa, it is mandatory. By law, every tyre manufacturer and importer must pay a waste management fee of R2.30 per kilogram to the Recycling and Economic Development Initiative of South Africa (REDISA), an industry-independent body that shoulders their recovery and recycling liability for them.
However, given the lack of success following the plastic bag tax, it is reasonable to query what the difference is between that, and the REDISA waste management fee.
While the money collected from the plastic bag tax still goes directly into the fiscus, funds collected by REDISA are paid directly to the organisation and there is no government involvement. REDISA then allocates spend of the money as clearly outlined in the gazetted REDISA Plan.
One of the key challenges of the plastic bag levy is that the funds collected go directly to the government fiscus. Therefore the Department of Environment Affairs (DEA) has to apply to the Treasury to get any of that money back in order to set up the promised recycling industry. When the REDISA Plan was established, Minister Molewa emphasised that the waste management fee collected would not end up in the general fiscus. The advantage of this is that REDISA is 100% accountable for what happens with the funds. This is monitored annually by an external audit partner, KPMG.
REDISA director, Stacey Davidson, said that “Once tyre manufactures pay the waste management fee, the manufacturers will not be required to handle the recycling of the tyres themselves. Instead, REDISA has taken over this responsibility and is ultimately developing an industry whereby old tyres are being recycled into new products.”
Source: African Environment
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