SA’s fiscal position to watch in Budget 3.0

The recent legal challenge to the value-added tax (Vat) Act has upended South Africa’s traditional budget process, leaving National Treasury with limited room to introduce major revenue measures the day the budget is delivered.

This, says Roy Havemann, economist at the Bureau for Economic Research, disrupts and complicates immediate fiscal planning. However, it may ultimately lead to better forward planning, as tax increases will henceforth need to be negotiated and implemented ahead of time.

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He expects new tax measures will have to be shifted to the Medium-Term Budget Policy Statement (MTBPS), which is usually delivered in October.

Budget 3.0 

Finance Minister Enoch Godongwana will table the third iteration of South Africa’s 2025 national budget on Wednesay (21 May), following two failed attempts earlier this year.

With a R75 billion revenue hole created by the scrapping of the planned Vat increases, Treasury will need to make difficult decisions to maintain fiscal consolidation while addressing slowing economic growth and mounting government debt.

The most significant change in Budget 3.0 is the removal of the proposed Vat increases – initially a two-percentage-point hike and later, in Budget 2.0, revised down to 0.5 percentage points in 2025 and 2026.

After strong political resistance – notably from the DA and the EFF – and a court order barring the Vat hike, Treasury now faces a major funding gap.

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Old Mutual Group chief economist Johann Els says the combined loss from cancelling the Vat increases planned for this year and next year totals around R75 billion.

In addition, the revised growth and inflation will likely shrink revenue further, compounding the shortfall.

What will plug the hole?

Without the Vat increase or significant new tax measures, Treasury’s options are limited, but it could consider a combination of possibilities, according to Els.

These include a potential petrol levy increase (but no other tax increases), which may generate some additional revenue. The other is to revisit strategies from the early 2000s, such as including a line item in the budget for improved tax collection (worth up to R5 billion).

“Neither of these will be enough to cover the full shortfall. Therefore, significant expenditure cuts, totalling over R75 billion over three years, will be required.”

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Given the added pressure from lower growth and inflation, the real gap may be even larger, Els cautions.

Tertia Jacobs, treasury economist and fixed income specialist at Investec, notes that bracket creep and excise duty increases may remain in play to raise additional revenue.

Patrick Buthelezi, economist at Sanlam Investments, expects Treasury to maintain the revenue-raising measures in the second iteration of the budget – not adjusting personal income tax brackets for inflation and introducing an above-inflation increase in excise duties.

“Clearly, there is no political appetite to raise taxes, judging by two failed budgets. Therefore, maintaining the government expenditure plans presented in Budget 2.0 will result in a wide budget deficit and higher borrowing,” says Buthelezi.

“The deficit will probably be wider in the near term, [but] the medium-term trajectory is expected to improve.”

Buthelezi expects Wednesday’s budget to focus on expenditure cuts, although there is limited time for a comprehensive expenditure review.

Borrow more?

Increased borrowing, although unpalatable, isn’t being ruled out, said people familiar with the budget process, who asked not to be identified because they aren’t authorised to comment.

If it is raised, they stressed, it would be by a conservative amount.

Treasury officials – who have entered their pre-budget quiet period and were not available for comment on Tuesday – have been reluctant to increase borrowing as debt-service costs, including interest payments on government debt, consume more than a fifth of South Africa’s budget revenue.

Improved revenue collection and spending cuts might have done the trick prior to the first two renditions of the budget being delivered – but since the Vat hike proposal in February, South Africa’s economic outlook has worsened amid US President Donald Trump’s sweeping tariffs and doubts over the coalition government’s stability.

Growth revisions indeed adding fiscal pressure

Downward revisions to GDP growth projections are expected to feature prominently in the new budget.

Els anticipates that Treasury will revise growth forecasts from 1.9% to 1.5% for 2025, “largely due to the impact of the global trade slowdown on South Africa”.

“However, there are upside risks: cyclical tailwinds, lower inflation, reduced interest rates, rising confidence, and fewer structural constraints. These could all support stronger growth than currently forecast,” he says.

The inflation outlook has also improved slightly. From an expected 4.3%, it is now forecast to come in about one percentage point lower.

“Although this offers some relief to consumers and interest rates, it also weighs on nominal tax receipts,” Els cautions.

Investec’s Jacobs notes that the downward revision in GDP will increase pressure on the budget to support growth-enhancing reforms. “The revised GDP forecast is likely to align with Treasury’s worst-case scenario.”

She adds that Budget 3.0 effectively fast-tracks decisions usually left for the October MTBPS. “This includes revised growth and inflation assumptions, which impact revenue projections and overall fiscal sustainability.”

Treasury ‘must stick to the deficit and debt targets’

Despite the revenue pressure and the comments above, Treasury is expected to recommit to its deficit and debt targets, which, according to Els, are as follows:

• A budget deficit of 4.6% of GDP this year, declining to 3.5% over the medium term;
• A primary surplus turning from -0.9% to +2% over three years; and
• Debt-to-GDP peaking at 76.2% and then stabilising.

“National Treasury must stick to the deficit and debt targets outlined in the first two versions of the budget,” says Els.

Buthelezi is of the view that the persistent pressure on government finances is not “a revenue problem” but rather a low economic growth trap.

“The government should prioritise growth-promoting areas, such as investment outlined in Phase 2 of Operation Vulindlela, to achieve a high growth trajectory in the future. Without an improved economic growth path, the debt trajectory will continue to rise.”

Els cautions that markets and rating agencies will react negatively if the debt and deficit targets are missed, especially if revenue shortfalls are covered through more borrowing.

“If National Treasury presents a credible budget that adheres to these targets, implements some expenditure cuts, and maintains reasonable growth expectations, then ratings agencies could begin upgrading outlooks.”

Listen/read: ‘Spending cuts were not effective, now we look to higher tax revenue’ – Godongwana

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