Despite the economy confronting significant challenges, government’s cautious approach to managing public finances has allowed it to provide short-term support to the economy. At the same time, measures are being undertaken to boost the economy in the medium term. In the short term, government has implemented inflation-linked adjustments to personal income tax brackets amounting to R15.7 billion of tax relief.  A tax relief of R13 billion is provided to support an increase in electricity supply and limit the impact of higher fuel prices. To avoid the severe short-term impact of load-shedding, government will support Eskom by providing debt relief to the value of R254 billion over the next three years. This should enable Eskom to focus on investment in transmission and critical maintenance, while reducing government’s contingent liabilities. To avoid pre-emoting the outcome of the public sector wage negotiations, government has kept growth in compensation of employees intact at 3.3% over the medium term. Critically, the Budget makes meaningful investment allocation for infrastructure of critical network industries, which should underpin growth over the medium to long-term horizon. Overall, the fiscal authority continues to demonstrate consolidation (and policy coordination with monetary policy) to ensure fiscal credibility and sustainability.

Economic growth

As expected, Treasury adjusted its 2022 economic growth estimate to 2.5% from 1.9% at the 2022 Medium-Term Budget. Economic growth for 2023 is lowered to 0.9% from 1.4% previously, reflecting the severe impact of higher stages of load-shedding, transport logistic challenges and a less favourable external environment. A sub-employment stimulating growth regime is envisaged over the medium term, with growth expected to average 1.4% over the 2023 to 2025 period, 0.2 ppt lower than previous projections. Treasury’s inflation forecasts remain steady at 4.9% over the medium term compared to 4.8% at the Medium-Term Budget.

Expenditure

The 2023 Budget review sees consolidated government spending growth of 4.5% over the Medium-Term Expenditure Framework (MTEF) to R2.48 trillion in 2025/26, with the lions share to be allocated to the social wage. At 8.9%, debt service costs are the fastest growing spending function which is expected to reach R1.10 trillion over the MTEF. Unfortunately, spending pressures may continue over the MTEF. These risks include added support to state owned entities, wage bill pressures as inflation will likely remain above pre-pandemic levels and headcount reduction is stalled by the need to improve service delivery and support employment during an election period. A replacement for the Social Relief of Distress (SRD) grant is yet to be determined and continuation of the grant is likely. Positively, government has unallocated reserves that provide a buffer for additional spending needs, but these are unlikely to cover large exposures i.e., higher wage bill growth.

Revenue

Treasury estimates a 2022/23 revenue overshoot of R10.3 billion relative to the 2022 Medium-Term Budget – this is slightly below our estimate of R12.9 billion. Revenue growth averages 5.6% over the medium term and remains higher than the 2022 Budget projections in levels. Weaker economic growth and higher inflation over the forecast would weigh on tax revenues.

Responding to Eskom’s electricity crisis

The budget firmly indicates that government is prioritising interventions to ensure sustainable and reliable electricity supply in the future. This follows the declaration of the State of Disaster by President Cyril Ramaphosa during the State of the Nation Address last week. Government has confirmed that it is providing debt relief to Eskom amounting to R254 billion (current Eskom debt is R423) over the next three fiscal years (2023/24 to 2025/26), split into R168 billion in capital and R86 billion in interest. Eskom’s debt relief comes with strict conditions to safeguard public finances and will strictly be used to settle debt and interest payments as they fall due. The debt relief takes the form of advances totalling R184 billion and split into R78 billion in 2023/24, R66 billion in 2024/25 and R40 billion in 2025/26. At the end of the debt relief period (2025/26), government will directly absorb R70 billion of Eskom’s loan portfolio. The advances to Eskom will be financed through the R66 billion baseline provision announced at the 2019 Budget and R118 billion in additional borrowing.

Fiscal ratios

Eskom’s debt relief alongside lower nominal GDP, higher interest rates, and a weaker currency, increases and delays the peak in government gross debt (debt stock) to 73.6% of GDP in 2025/26 (previously 71.4% of GDP in 2022/23) and lifts the overall trajectory throughout the forecast horizon. Critically, over and above other obligatory conditions, Eskom is required to strictly channel its capital expenditure to transmission and distribution infrastructure.

The main budget deficit is estimated to be 4.5% of GDP for 2022/23, narrowing to 3.3% of GDP by 2025/26. Importantly, the economy records a primary surplus (i.e., the balance excluding interest expenditure) of 0.1% in the current fiscal year, widening to 1.7% of GDP by 2025/26.

Economic implications

The budget addresses critical challenges facing the economy such as the need to improve spending on infrastructure, strengthen the criminal justice system, alleviate constraints in healthcare and the energy crisis that is crippling the economy. To achieve these objectives, expenditure has been increased and reprioritized over the MTEF.

Importantly, the budget adequately caters for the challenges facing Eskom by restructuring its debt. Solving the energy crisis is arguably one of the most important reforms that need to be addressed with a high degree of urgency. However, the implications of the debt restructure mean that South Africa’s debt will increase significantly, and debt service costs will accelerate, making for a stark trade-off between much needed spending on growth-enhancing interventions and servicing debt.

We view today’s budget as appropriately addressing the binding constraints facing the economy which, over time, will have a positive effect on economic growth. In addition, lower contingent liabilities should assist with lowering South Africa’s risk premium and lending rates. However, there is a great degree of risk around the stabilization of debt and narrowing of the fiscal balance. Spending on the social wage and support to state owned entities remain a significant risk.

Market implications reaction: Chantal Marx, Head of Investment Research at FNB Wealth and Investments

Against a backdrop of substantial economic growth constraints, this was a decent budget from a market perspective – probably more equity friendly than bond friendly relative to expectations. During the speech, the rand strengthened, and bond yields came down slightly across the curve. The equity market picked up from intra-day lows. The Financials 15 index along with the Mid-cap index (which are good proxies for SA Inc.) moved up.

For bonds: A sustained commitment to debt consolidation will be welcomed by debtholders. Budget deficits are forecasted to be slightly smaller over the medium-term expenditure framework than what the market was expecting. A primary surplus this year along with further surpluses forecast will be good news for bond holders, but gross government debt will now peak later and higher than expected due to lower growth estimates, a weaker rand, and the take-over of Eskom debt. Government is providing debt relief of R254 billion to Eskom – slightly lower than what we expected, but it will make great strides in stabilising the balance sheet of the embattled state utility.

For equities: This was a positive budget for equities as there was some tax relief for personal income taxpayers, with adjustment for bracket creep, support to increase electricity supply (individuals and companies) and limit the impact of fuel price increases. While the public sector wage bill was budgeted to increase by just 3.3% over the medium-term expenditure framework, grants were adjusted for inflation. It was also confirmed that the Social Relief of Distress grant will be extended further. As was known to the market, the corporate tax rate is declining from 28% to 27% next month.