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The National Budget (2) Crunching the numbers
Date: 11 Feb 2010
In the first instalment of my pre-budget commentary I argued for an increased emphasis on top-down budgeting as a way to ensure greater discipline in government spending. Setting an overall limit to government expenditure and sector allocations will help to ensure the long-term sustainability of the public finances and encourage greater awareness of the need to align Government’s priorities with the available resources.
But at the end of the day the budget is about the numbers and how they add up, and the uncertainty in this regard is currently at an abnormally high level. This is also the first budget in many years that could see meaningful tax increases.
The consolidated fiscal framework as set out in the Medium Term Budget Policy Statement (MTBPS) in October 2009 can be summarised as follows:
R billion | 2009/10 | 2010/11 | 2011/12 | 2012/13 |
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Revenue | 657.5 | 743.5 | 833.4 | 921.3 | % change | -5.0% | 13.1% | 12.1% | 10.6% | % of GDP | 27.3% | 28.4% | 29.1% | 29.6% | Expenditure | 841.4 | 905.6 | 975.6 | 1052.8 | % change | 17.6% | 7.6% | 7.7% | 7.9% | % of GDP | 35.0% | 34.6% | 34.0% | 33.8% | Budget balance | -183.8 | -162.1 | -142.1 | -131.5 | % of GDP | -7.6% | -6.2% | -5.0% | -4.2% |
The first question is whether Government will meet the projected budget deficit of 7.6% of GDP for the current fiscal year. The fact that as at 31 December 2009 (the latest available numbers) revenue as a percentage of the budgeted amount was 0.8 percentage points less that at the comparable stage in 2008, and expenditure 0.9 percentage points higher, points to the possibility of a marginally higher deficit. Should the current trends prevail; the budget deficit will amount to 8.1% of GDP. But is this a realistic expectation?
Due to the lack of information on the nature of the slight “overspending”, it is difficult to judge whether this is merely a matter of funds being drawn down a little more quickly, or whether there is a real possibility that expenditure for the full fiscal year will exceed the budgeted amount. For example, if the uptake of social grants has accelerated to above budgeted levels owing to the human cost of the recession, it would make overspending more likely. However, if the past three fiscal years are any indication, it is just as likely that expenditure could turn out to be slightly less than budgeted in the MTBPS.
The risk that government revenue may fall short of the projections in the MTBPS is perhaps more real. Although the economy started moving out of recession in the third quarter of 2009, economic activity remains weak. This is especially true of household consumption expenditure, with retail sales in November 2009 in real terms 6.6% lower year on year, indicating that revenue from VAT remains under pressure.
Nevertheless, revenue from VAT in December 2009 accounted for 10.6% of the budgeted amount, compared with 7.6% in December 2008. The year-to-date amount equalled 74.8% of the budget total in December 2009, which is substantially more than the corresponding level of 70.5% a year ago. In my commentary of 16 October 2009 on the MTBPS I expressed the thought that businesses were perhaps delaying their VAT payments to save on working capital – this is possibly now being unwound. However, the same trend can be observed with regard to the other two major indirect taxes, viz. levies on fuel and customs duties, as well as taxes on corporate income, which perhaps rather indicates tougher surveillance by SARS.
To conclude, the estimate for 2009/10 to be reported in the budget next week is unlikely to differ meaningfully from the numbers presented in the MTBPS. An estimated deficit of 8% of GDP appears to be the worst possible outcome.
But what about the budget for the next three years?
The first question is whether the budgeted average increase in expenditure of 7.7% per annum (1.7% in real terms) for the next three years is achievable. With 2009/10 being an exceptional year, the average increase of 15.5% per annum in nominal terms and 6.7% in real terms in consolidated expenditure in the three years to 2008/09 is a better benchmark. At a glance it illustrates the severe challenge Government will face in limiting the growth in expenditure to the budgeted numbers in future years.
One should of course judge these increases in the context of a rapidly expanding social grant system (the number of social grant beneficiaries, for example, increased from 9.4 million in April 2005 to 13.4 million in April 2009) and an exceptionally strong increase in public sector infrastructure spending from R70.7 billion or 4.5% of GDP in 2005/06 to R190.6 billion or 8.3% of GDP in 2008/09. Both these developments will not be fully repeated in the next three years, although the number of social grant beneficiaries will continue to expand due to the extension of the child-care grant and the social old-age pension for men, and Government’s role in the financing of Eskom’s building programme still needs to be clarified.
Unfortunately other potentially large expenditure items that will have serious fiscal implications, are looming, viz. an extended national health insurance system and further down the line a reformed national social security system. It could be argued that these initiatives will at least in part be financed by new social security taxes and will therefore not upset the budget balance, but Government will have to think very carefully about the road down which it is taking South Africa.
South Africa’s public finances appear to be headed for a decidedly European look, while its labour dispensation also has much more in common with Europe than with a typical emerging-market country. The risk of South Africa contracting so-called Euro-sclerosis is very real, with the difference that Europe first became rich and then sclerotic, while South Africa is still faced with an enormous challenge of poverty and inequality.
In short, South Africa’s future budget plans will have to reflect its stage of development in its choice of priorities. Although the merit of alleviating the immediate plight of the poor is not to be argued, we should not lose sight of the goal of enabling people to escape permanently from the poverty trap in which they find themselves.
It is likely that the revenue projections will be revised upwards in the coming budget. Government’s forecast of economic growth of 1.5% in 2010 and 3% on average in the next two years is clearly conservative when compared with the Reuters consensus forecast of 2.6% growth in 2010 and 3.6% per annum in the next two years. An upward revision to GDP growth will not only boost projected revenue but will also contribute to improving the fiscal ratios by raising the denominator.
However, that would not alter the reality that South Africa’s growth is going to be lower on average in the next five years than in the previous five years. In fact, it is becoming increasingly clear that the earlier view that the potential growth rate has increased to 4.5% was premature and 3.5% would probably be closer to the truth. Previous budgets during the boom years did indeed warn against the sustainability of the high-growth years and their favourable impact on government revenue. It will therefore be wise to use any upward revision to the revenue side of the budget to reduce the deficit more rapidly rather than increase expenditure even more.
But the die has been cast in favour of higher taxes. To quote from the MTBPS, “…other means of increasing budget revenue will need to be considered. These include broadening the tax base, improving tax compliance and the introduction of new taxes (such as environmental taxes to achieve both environmental and revenue objectives)”. Even if income tax rates remain unchanged (although Government this time will probably be tempted not to fully compensate individual tax payers for fiscal drag), effective tax rates will probably increase through further curbs on deductions and what could generally be regarded as tax expenditure items.
It therefore appears likely that the tax burden will increase to more than 30% of GDP. But taxes, through their level as well as structure, unfortunately create incentives and disincentives that can influence economic outcomes profoundly. And although punishing the private sector has become fashionable in the wake of the global financial crisis, the wealth-creating role of the private sector should not be lost sight of, and tax policy should reflect this reality.
The developments concerning Greece serve as a timely warning to emerging-market countries such as South Africa to keep their public finances in shape. Unlike Greece, South Africa does not operate under the protective wing of a major economic bloc that will support it in difficult times, even if the latter is motivated by protecting its own interests rather than by altruism. Of course, South Africa is not nearly in the same position as Greece’s, as both its budget deficit and debt/GDP ratio are at much lower levels, but then its margin for error is so much smaller.
The MTBPS projects total government debt to increase to 41.1% of GDP in 2012/13, but the dynamics around the primary balance indicates a continuing deterioration after that. Standard & Poors, the international rating agency, recently indicated that it expects South Africa’s debt/GDP ratio to peak close to 50%, which is in line with my own estimates.
The pity of the increase in debt is that it will reverse the decline in debt-servicing costs that largely enabled the smooth expansion of social grants (see my commentary of last week.) Increasing debt-service costs that will arise not only from higher debt levels but also from higher long-term interest rates will require even greater savings in other categories of spending.
Another important aspect of the budget deficit and debt position is of course the contribution government dissaving is making to the current account deficit and South Africa’s dependence on foreign capital to finance investment. Although the current account deficit improved during 2009, the fact that it has taken a recession to get the deficit down to less than 5% of GDP is not comforting. And once the economic recovery takes hold, it will head back up.
South Africa remains dependent on inflows of portfolio investment capital to finance this deficit, and events of the past 18 months have demonstrated how vulnerable that makes the country to the ebb and flow of global risk appetite. Much has been written about the need to improve South Africa’s poor savings record, and Government will have to take the lead in this regard.
But what about the cyclical context? Does the expected muted recovery not justify further fiscal stimulus?
As a starting point, it would be premature to move to a tightening fiscal policy stance this year. However, in view of the already high deficit and difficulty of reining it in, further fiscal stimulus is not to be recommended. Should the economy need further lifting, it should rather be done through monetary policy, even if it is somewhat late in the cycle, which can just as easily be reversed.
Some people will possibly interpret this as a plea for the abandonment of inflation targeting, but what I have in mind is rather that the Reserve Bank could use its new-found space to return more explicitly to its role as flexible inflation targeters without having to worry about a possible loss of credibility.
What the Minister will probably say about inflation targeting is that the discussions on its future are still continuing, and perhaps provide more detail on the process. What he should be saying is that it is a rather fruitless debate because the critics of inflation targeting are barking up the wrong tree.
Finally, I do not envy the Minister of Finance and his team who have to draw up this budget in the most challenging conditions faced by them since 1994. To find the right balance between all the demands on the fiscus while keeping a close eye on the macro-economic consequences of fiscal policy will be no easy task.
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