The presentation of the Medium Term Budget Policy Statement in Parliament yesterday was unusually important for two reasons. It was the public baptism of the recently appointed Minister of Finance, Pravin Gordhan, who would be presenting the revised three year outlook for government spending and revenues in much changed economic circumstances.
The severity of the recession had made nonsense of the Government’s Revenue projections made in February this year. Gross tax revenues estimated for fiscal year 2009-10 have now been revised markedly lower by R70bn from the R659.3bn expected in February to R589bn, or from 26.6% to but 24.5% of a significantly lower expected GDP. Expenditures have been revised modestly upwards by about R16bn, so lifting the budget deficit from an estimated R95.6bn in February to the latest estimate of -R181.6bn and requiring additional, not previously planned, debt issues of R85.5bn. Government expenditures are now equivalent to an unhealthily large 35% of GDP. Unhealthy in normal circumstances but temporarily helpful in offsetting the sharp decline in private spending
The unknowns to be resolved yesterday were about style: how would the Minister present himself and be received, and about content, and how would the government address the much more difficult economic circumstances in its plans for revenue collection and spending?
Comfortably in command
On the question of appearance and reception the Minister was very well received. South Africa, one would suggest, has found a worthy successor to Trevor Manuel. The rookie Minister was comfortably in welcome command of his brief. Especially welcome since the content of his proposals and projections were eminently sensible and represented the continued commitment to fiscal conservatism of the SA government.
The immediate recessionary dangers facing the economy were well recognised – no pro cyclical increases in tax rates are proposed – and the extra borrowing requirement is to be wisely tolerated, given the strength of the balance sheet.
While, as was pointed out, the financial situation of the SA government has deteriorated more severely than almost anywhere else, the ratio of government debt can be allowed to increase from the currently low 23% of GDP to an estimated, much less comfortable 41% of GDP in 2012-13 when the economy will have recovered to a degree. The interest expense on the Budget will have risen by about R40bn or around R100bn a year. But importantly the plan thereafter is to reduce dependence on debt finance to reduce spending on interest and to restore the still highly valued balance sheet strength. This will allow spending on much more valuable other services to the hard pressed South African public. It should be appreciated that fiscal strains in the developed world will see government debt to GDP ratios rising above 100% within the next year or two – a much more difficult condition than that faced by South Africa.
A very conservative U-shaped recovery is predicted by the Treasury, though its forecasting credentials will not have been improved by the recent underestimates of economic activity. GDP is estimated to decline this year by 1.9% and to grow next year by only 1.5% and to then pick up to a still modest 3.2% rate of growth in 2012. Such an economic outlook, taken with the established and appropriately careful approach to issuing more debt, make for highly constrained plans for extra expenditure and revenue between now and fiscal year 2012/13.
The framework allows for government expenditure to grow at a compound average growth rate of 7.8% per annum and for revenues to grow faster, to partially close the deficit of 11.9% a year. The deficit is thus planned to decline from an estimated R183.8bn in 2009/10 to R131.5bn in 2012/13. Since inflation is expected to average around a still high 6% a year this will mean minimal growth in real government spending, though much faster growth in real government revenues is predicted.
The intention to reduce deficits and to contain real government expenditure is admirable. Whether such revenue estimates will prove consistent with macro-economic stability remains to be seen, especially if Eskom is allowed to tax the hard pressed consumer to the extent it has proposed. The Treasury has set its face against further debt issues by the central government and further guarantees of the debt issued by state enterprises including Eskom. Over R170bn of additional Eskom debt has already been guaranteed by the Treasury and we may hope that this will allow for electricity prices that make long run economic sense and do not damage the economy in its current fragile state. Perhaps in the strained circumstances actually selling off a power station or two, accompanied by an attractive enough price for the electricity to be fed to the grid, will seem like a good financial deal.
The strained financial conditions would also seem to have ruled out expensive health care innovations at least for the foreseeable future. They have also led to grave concerns about the size of and employment benefits of what has become an increasingly well paid government employee. The scope for further improvements in public sector conditions of employment are being recognised as very limited.
Hamlet without the Prince
The government in this Budget Review could not have been more frank about the large scale failures of its own administration and then the need to address its inability to service the community. To quote the Budget Statement: “The functioning of the public service requires fundamental reform to obtain better value for public money, to do more with less, and to build a culture of responsible stewardship so that citizens trust the institutions of service delivery…..”
Such self recognition is very welcome as a starting point to reforms that are essential to the purpose of a better South Africa. Also welcome is the recognition of the extreme gravity of the employment problem that is graphically illustrated in the Statement. South Africa’s ability to offer employment, that is to say its ability to absorb labour, appears weaker than almost anywhere else in the world with only 42% of the age group 15-64 in employment. To quote the government again, “creating jobs, particularly among millions of relatively unskilled South Africans, is the country’s greatest economic challenge….” A number of interesting innovations are proposed to this end, but a discussion of this issue without reference to the employment destructive role of unions – or how such employment objectives can be met without the essential services of labour brokers – is bit like Hamlet without the Prince.
Helpful to the goal of a stronger economy are the steps taken and intended that will enhance the flexibility of monetary policy. Also signalled by the Treasury was a more flexible approach to inflation targeting that took account of forces acting on inflation that was beyond the influence of monetary policy.
The significant exchange control reforms announced have been timed to counter an unwanted degree of rand strength. The Brazilians have imposed a tax on capital inflows to this purpose. More impressively South Africa has provided greater freedoms to move savings in and out. The currency market however did not react at all to the news – though the rand had responded earlier yesterday with weakness and again today to the downward pressure being exerted on emerging equity and commodity markets accompanied by the stronger US dollar. We show below how little reaction to the Budget statement made at 14h00 was observed in the currency market, while the market in RSA debt reacted favourably to the news.
R157 bond
Rand/US dollar
Graph sources: Bloomberg
Clear evidence that the government continues to budget conservatively and wisely under capable guidance is very welcome. Very welcome too is the recognition of its own failures to deliver services and employment opportunities as an essential starting point for reform. But the state of the economy remains very fragile and every effort will still have to be made to encourage domestic spending for the sake of incomes employment and government revenue.