What Budget 2019 means for investors

The 2019 National Budget will forever be remembered as ‘the Eskom Budget’ – and with good reason. It contained the largest bailout in South Africa’s history as it announced a government injection into troubled state-owned Eskom of R69bn over three years.

The National Treasury now expects widening deficits, resulting from the support to Eskom being greater than under-spending elsewhere.

The main fiscal deficit is seen as widening to 4.7% of GDP in FY19/20, before narrowing to 4.3% in FY21/22. The spending ceiling will be breached and the debt-to-GDP ratio has been elevated slightly to 58.9% (58.5% previously) and is expected to peak at 60.2% in 2023/24. Government also experienced a pronounced deterioration in contingent liabilities.

The amount of cash injections to Eskom “was broadly in line with our initial thoughts for 2019, although the increase in the expenditure ceiling by R16bn to meet needs over the next three years came as a surprise,” say Bank of America Merrill Lynch economists, Rukayat Yusuf, Gabriele Foa and Ferhan Salman.

Ratings agencies

The question on the lips of many analysts and investors is: How will the ratings agencies view Budget 2019? In the press conference on the day of the Budget Speech, the Minister of Finance, Tito Mboweni, remarked to reporters: “Treasury has been having difficult conversations with the ratings agencies and we’ll be going on a roadshow next week.”

Stanlib Chief Economist, Kevin Lings, expects that the budget may buy South Africa some time with these agencies, “in particular Moody’s Investors Service, which is the only ratings agency to maintain the country on an investment grade, with a stable outlook. It is likely that Moody’s will downgrade the outlook to negative in March and will make another assessment later of how the government is fulfilling its promises. If there is no growth, an increase in the deficit and a worsening of the debt burden, we believe SA is likely to face a ratings downgrade in the medium term.”

Budget 2019 from an investing perspective

“Widening deficits are normally seen as being more equity than bond friendly, but this budget is neither,” says Chantal Marx, Head of Research at FNB Securities. “Spending is being cut back so the economic environment will remain challenged from a risk asset perspective, while borrowing requirements have gone up, keeping bond supply under pressure.”

Marx lists some of Budget 2019’s more specific impacts on South African equities:

• While there were no changes to income tax brackets, there were also no adjustments made for bracket creep. This, together with higher ‘sin taxes’ and fuel levies, will have a negative impact on the consumer – offsetting this somewhat will be a longer list of zero-rated VAT items (but this was already known prior to the speech). Medical aid tax credits have not been increased. Grant payments were increased by approximately 5%. Pressure could translate into top-line pressure for consumer stocks.

• Specific to ‘sin taxes’, excise tax on beer/cider, wine and spirits is to rise by 7.4%, ahead of CPI. This will be negative for the likes of Distell.

• Sugar tax was adjusted for inflation. This will have a marginally negative impact on food and beverage producers.

• Moving forward with proposals from the 2012 budget, government intends to publish draft legislation this year on a proposed 1% gambling levy to fund rehabilitation and awareness-raising programmes. This could have a medium-term impact on the likes of Tsogo Sun and Sun International.

• The introduction of carbon tax on 1 June 2019 will be negative for large emitters like Sasol, the steel industry, and other manufacturing groups. Sasol has previously estimated the impact on its income statement specifically at between R700m and R2bn a year.

• The higher fuel levy will be negative for logistics companies, although many operate on a pass-through basis.

• Because of the way ad valorem excise duty is calculated, vehicles produced locally are taxed at a higher rate than imported vehicles. To remove this anomaly, government proposed to align the tax treatment. This could provide some support to the local vehicle manufacturing industry along with motor vehicle retailers and they could use this opportunity to restore margins, which have been under immense pressure over the last few years.

• Lower capital expenditure near term by government will be a net negative for infrastructure players – specifically in the construction space. A commitment to longer term support for the infrastructure fund will be positive.

• An additional R3.5bn has been made available to improve non-toll roads. This is expected to be positive for the likes of AECI and Raubex.

• There was no new information provided on the NHI. Although probably marginally positive (it seems as if government will delay implementation), the overhang for SA hospital groups will likely persist.

Meanwhile, it’s encouraging that Budget 2019 has not placed any limitations or constraints on South Africans’ ability to invest internationally, says Erik Olwagen, Provincial Head, Standard Bank Wealth International, Offshore Services South Africa. “South Africans will continue to be allowed to utilise their annual R1m discretionary allowance, and up to R10m foreign investment allowance – with tax clearance. These remain very generous allowances in a fiscally constrained environment,” Olwagen adds.

No changes to taxes impacting investors

In his Budget Speech, Minister Mboweni did not announce any material changes to the key taxes impacting investors. “The rates for marginal income tax, dividend tax, capital gains tax and VAT all remained unchanged,” says Pieter Koekemoer, Head of Personal Investments at Coronation.

He reminds investors that they qualify for the following investment-related tax breaks:

• Marginal tax – Individuals pay a lower marginal tax rate on capital gains (18%) and dividend income (20%) compared to interest, rental and salary income (45%). This means that investors not using tax-advantaged vehicles are, all other things being equal, better off holding equities in their portfolios than other assets.

• Tax-free investments – Tax-advantaged contributions to a tax-free investment accounts remain at R33 000 per year. This arguably remains the best tax break available to individual investors with long-time horizons at the moment. While you use after-tax money to invest in a tax-free investment, all income and growth earned from the underlying funds are tax free, and all proceeds at the time of withdrawal will also be untaxed. There are also no investment restrictions for tax-free investments. Just do not over-contribute – contributions in excess of the annual R33 000 limit are taxed very punitively.

• Retirement funds – Tax-deductible contributions to retirement funds remain at 27.5% of taxable income (excluding retirement benefits and capital gains) or R350 000 annually. Your capital and reinvested income will grow tax free while it remains in the retirement fund, and you will only pay tax on the way out when you start to withdraw from your retirement fund (at the then-prevailing tax rate). Your underlying investments must comply with Regulation 28 of the Pension Funds Act, which sets a limit on the level of exposure you can have to equity, property and offshore assets.

• Interest exemption – The general interest exemption remains R23 800 for investors under 65, and R34 500 for investors over 65. At the current yield of around 8% on managed income funds such as Coronation Strategic Income and Coronation Money Market, this means that you can invest approximately R300 000 if you are under 65 or R430 000 if you are over 65 before starting to pay tax on interest earned.

• Capital gains – The annual capital gains exclusion of the first R40 000 of gain is unchanged. This exclusion makes it more efficient to stagger the realisation of capital gains over different tax years.

• Endowments – Endowment policies also remain attractive for certain long-term investors. Individual investors in these investment policies currently pay effective tax rates of 30% on rental income, 20% on dividend income and 12% on capital gains.

Finance Minister, Tito Mboweni

Russell Roberts Photograhy