The upcoming 2014/15 Budget speech on 26 February 2014 is essentially about four specific areas for South African investors, namely, how much the government expects in tax revenue, how much it plans to spend, how it will divide its spending between competing priority areas and how much it will need to borrow should there be a deficit.
This is according to Dave Mohr, Chief Investment Strategist for Old Mutual Wealth, an advice-led, wealth management business, who says that these factors can influence an investment portfolio, but that the impact will vary over time and also depend on other market factors.
In terms of tax revenue growth, a government’s tax revenue typically moves in line with the overall economy, says Mohr. “A buoyant economy generates strong tax revenue growth and could provide the government with scope to reduce tax rates. Such a scenario is positive for profits of companies that do business in South Africa. Improving profits in turn drive share prices over the longer term. However, in a sluggish economy that doesn’t generate enough tax revenue for the government, tax rates might have to rise, putting pressure on company profits.
“Our government has already increased dividend withholding tax (DWT) and capital gains tax (CGT) rates over the past year – tax rates that are directly applicable to investment returns.”
Mohr however expects government will be reluctant to hike tax rates in an election year and prior to the completion of the current review on tax reforms by the Davis Tax Committee. Mohr adds that government is eager to encourage savings, particularly retirement savings. “Government has been introducing measures to improve the attractiveness of retirement fund contributions, and could be looking to change the way interest income is taxed.”
He says that government has indicated that it will reduce the real growth rate of its expenditure to roughly 2% per year in real terms over the next three years, in an attempt to bring the budget deficit down and thus stabilise the overall public debt level at around 40% of GDP.
“The four major growth drivers of the local economy are consumption expenditure, fixed investment, government spending, and exports. If government spending slows relative to overall economic growth, while at the same time tax rates don’t fall, it means government will be a drag on overall economic growth. Fixed investment, already stuck in first gear, tends to be the first casualty of a slowdown in overall spending and consumer spending is also likely to downshift gears, as the pressure on household finances build. Under such a set of circumstances the economy will then need to rely on its export sectors to boost economic growth and this is where a weak Rand is welcome. We have already seen the shares of companies that earn the bulk of their revenues overseas do very well on the JSE.”
Mohr adds that slower government spending growth could also affect the SA Reserve Bank’s interest rate decisions, and result in less aggressive interest rate hikes.
The Budget speech will be an indication of the way in which government will allocate its spending between various departments and agencies, which will have an indirect impact on investments, says Mohr. “Over the past five years, government’s ‘current’ spending - mostly salaries and welfare payments - has grown rapidly. This has been supportive of consumer spending and the shares of those companies that sell consumer goods and services have done well over the past five years.”
He adds that while government intends to – and absolutely has to – slow its current spending and increase its capital spending on expanding the country’s infrastructure, the shift from current spending to fixed investment spending has been slow and is unlikely to shift dramatically given current revenue constraints.
Together with the budget deficit, the country’s current account deficit – something which captures SA’s economic relations with the rest of the world – is also important. Mohr says that the market and credit ratings agencies have become wary of emerging economies with large ‘twin deficits’ “As a result the rand has depreciated and bond yields have risen, making any future borrowing more expensive for the government.” The October mini-Budget noted that interest repayments on past borrowing was already the fastest growing item in the budget, running at around R100 billion a year.
“Yields have risen in part because the market is concerned about the sustainability of government finances and higher government bond yields push up longer term private sector borrowing costs. Similarly, any change in the government’s credit rating will filter through to domestic companies’ ratings too, potentially further increasing borrowing costs across the board.”
Mohr says that the government needs to convince the market and ratings agencies of its seriousness in narrowing the deficit, which would relieve upward pressure on interest rates and potentially take pressure off the currency. “For investors holding bonds, this could see the value of their bond holdings appreciate. On the other hand, higher yields present a buying opportunity for those not currently holding them,” concludes Mohr.