South Africa’s budget speech on 21 February 2024 gave two clear indications that our government is facing financial pressure.
The two indicators of financial pressure.
The first indicator was failing to apply an inflationary adjustment to the income bands in the personal income tax table. This will result in “bracket creep” and can be seen as a form of stealth taxation, as can the failure to increase annual exemptions for inflation (e.g., the annual capital gain exemption of R40,000 and the interest income exemptions).
The second was the announcement of the withdrawal (spread over the next three years) of R150 billion from the Reserve Bank’s Gold and Foreign Exchange Contingency Reserve (GFECRA).
What are these reserves and where will they be utilised?
The reserves have accumulated on hard currency assets that the Reserve Bank acquired many years ago, and the weakening rand has resulted in the GFECRA balance growing to more than R500 billion.
The withdrawal of these assets from the Reserve Bank’s balance sheet will be used to pay off government debt, thereby reducing borrowing costs. This could in itself be viewed as a positive step.
Do we have enough reserves to let some go?
A certain quantity of hard currency reserves will always be required to cover potential foreign exchange losses caused by currency movements, and for unexpected national economic emergencies. However, South Africa is fortunate to have a relatively low proportion of hard currency-denominated government loans, relative to rand-denominated debt, and hence there is arguably scope to hold lower reserves than other countries that have different debt profiles from us.
Mostly a good thing?
Most respected economists have cautiously welcomed the GFECRA initiative, but with the clear proviso that the funds must indeed be used to reduce debt, rather than to simply fund ongoing government spending.
Here’s the possible downside?
What is unusual in the South African context is that the Reserve Bank is a privately-owned organisation, more separate from the National Treasury division of government than is the case with many other countries.
As a result, on the negative side there are a couple of concerns. One is that our Reserve Bank’s independence could be compromised in the future (whereas up to now they have been widely admired for their management expertise and financial discipline). The other is that dipping into foreign reserves could defer much-needed structural reforms that would help grow the economy and increase future tax collections, reducing pressure on our fiscus.
Continuing rand weakness.
Another important implication of the GFECRA decision is that those in charge at National Treasury and the Reserve Bank are effectively acknowledging that the South African rand (ZAR) is likely to continue weakening over time.
We know this because rand strength would reduce the value of foreign reserve holdings thereby limiting the Reserve Bank’s toolkit in a time of crisis, and they would not have agreed so readily to the Minister of Finance’s withdrawal proposal if they felt that it would compromise their functioning in future.
What else do we need to take into account?
The broader implication of this reduction in the Gold and Foreign Exchange Contingency Reserve is that personal tax planning will become increasingly important in the years ahead. This is because currently there is no expectation of a return to higher economic growth rates to help reduce the tax burden on our relatively small number of individual taxpayers.
Tax and investment planning are closely related as both involve the choice of appropriate investment vehicles, as well as suitable investment strategies within these vehicles.
Different investment strategies produce different proportions of income and capital growth, which in turn are taxed at different rates within different investment vehicles.
While income tax liabilities are ultimately unavoidable, appropriate portfolio structuring (including the allocation of assets between spouses) can reduce that liability over time. Speak to your CERTIFIED FINANCIAL PLANNING® professional about how you can optimise your investment portfolio for taxation and estate planning purposes.
By Richard Sparg, CFP® CA(SA)
