More Budget 2010 analysis

Arthur Kamp, Sanlam Investment Managers Investment Economist writes that government has committed to an achievable, sustainable fiscal policy.

In the 2010 Budget, Finance Minister Pravin Gordhan gives a firm commitment to pursuing fiscal sustainability. In reality, however, this will only be possible if: 

• The economy delivers a protracted economic upswing through 2015 (5 years of growth)
• Expenditure must decline as per cent of GDP as projected by Treasury, despite increasing demands on the fiscus and the state’s commitment to taking on responsibility for job creation
• The expenditure assumption may not be possible - requiring an increase in the tax burden to maintain fiscal sustainability 

Even though governments around the world are rethinking macroeconomic policy and have embarked on unprecedented fiscal expansion programmes, it is still recognised that fiscal sustainability is vital. In fact, current thinking is that governments should build up “fiscal space” during the good times so that they have a buffer when crisis hits again and government finances deteriorate.

Keeping to medium- to longer-term fiscal policy commitments, such as the medium-term budget framework, is thus a critical indicator of government’s attitude towards sustainability. Against this backdrop, it’s good news that Minister Pravin Gordhan has not deviated at all from the published MTBPS targets, which aims to keep SA on a path of fiscal sustainability.

Challenge of constraining real expenditure growth

The question is whether the National Treasury can manage to reduce the Budget deficit from 7.3 % in 2010/11 to 4.1 % in 2012/13 and restrict the rise in its debt ratio to 43.1 % by 2012/13 as envisaged in the Budget? The risk is that consolidated expenditure does not decline from 34.1% of GDP in 2010/11 to 32.1% by 2012/13, as indicated by the Treasury. The jury is still out on this. Success depends heavily on the Treasury’s ability to constrain average annual real expenditure growth to 2% over the next three years. Its projections rely heavily on restraining government’s compensation bill to an average of 7% a year and transforming of the public sector by cutting unnecessary expenditure, rationalising the public sector and reprioritising spending to ensure the bulk of the spending supports jobs creation, education and health.

Compensation amounts to no less than 33% of total non-interest spending. Thus its projections seem difficult to achieve considering the State is likely to be a net jobs creator – especially since the Budget projects moderation in the annual advance in compensation from 8.7% in 2010/11 to just 5% in 2012/13. The increase for 2012 reflects a decline in real terms considering the Treasury’s 5.9% inflation forecast for that year. Moreover, while the debt ratio is expected to stabilise by 2015, that is the year National Health Insurance is back on the agenda.

SA’s fiscal space enables government to support economy

SA’s saving grace is its low gross debt ratio of 32.5 % of GDP, which has created significant fiscal space, enabling it to act in support of real economic activity until the private sector regains momentum.

However, the leeway available to the Treasury is not limitless. Debt servicing costs, a key measure of fiscal stability, continues to rise as per cent of GDP – and the level of debt is not expected to stabilise before 2015. Hence, a continued decline in the primary budget balance deficit is required beyond the MTBPS period. This implies government is relying on an extended economic upswing beyond three years that delivers firm growth. That is possible, but not guaranteed. A downturn in the economy against a backdrop of a debt ratio expanding towards 50% of GDP would put long-run fiscal sustainability at risk.

The problem is that the ratio of tax (or revenue) is already high relative to GDP. To reduce the deficit over the next three years, the government plans to rely on revenue growth in excess of GDP growth. This implies a broadening in the tax base and the introduction of additional taxes.

There is no room to reduce the level of revenue to GDP over the medium term, which remains high at 28% by 2012/13 from 26.8% in 2009/10.  This also leaves no room for slippage on deficit projections due to higher-than-expected expenditure. To maintain fiscal stability, the State has drawn more and more resources from the private sector over the past 10 years. Indeed, in 2000/01 the ratio of revenue to GDP was just 23%.  But, the revenue ratio cannot be increased indefinitely.

One particular concern is that the above does not reflect the sharp jump in the public sector borrowing requirement (PSBR) in recent years, which includes state-owned enterprises such as Eskom and Transnet.  The PSBR remains exceptionally high at 11.1% of GDP in 2010/11 and declines, but only to 7.1 % by 2012/13.

Proactively addressing employment creation

Meanwhile, government has been forced into taking a more proactive stance in employment creation. The fall in government’s debt ratio over the past decade and the shift to single digit inflation from double digit inflation, lowered the structure of domestic interest rates and boosted private sector investment and job creation in the run-up to the global crisis. But, it has not been enough.

The country’s unemployment problem is structural and the education system’s failure to deliver in an economy where economic activity is increasingly skewed towards skill-intensive sectors, has prompted direct intervention in the jobs market. The infrastructure spending programme, including the expanded public works programme, has been the focal point of government intervention to boost employment up to now. According to the Budget, government aims to create 4.5 m temporary jobs over the next 5 years.

However, given an unemployment rate of 24.3 %, additional intervention is required. More than 13m South Africans, or some 27% of the population, rely on social welfare grants to live on. Hence, the 2010/11 Budget introduces an additional targeted measure to support job creation through wage subsidies.

There is no debate this intervention is necessary. As the MTBPS (2009) states: “If the country does not find a way to resolve this problem, there will be catastrophic implications for social stability and future growth “. However, government’s push to boost employment must ultimately necessitate the introduction of additional taxes. Put differently, the inability of the country to deal with its supply-side constraints, such as the lack of skilled labour has left the unemployment rate at an unacceptably high level, implying long-term risk to the country’s fiscal position. There was the usual increase in excise duties and the general fuel levy, but overall this Budget contained little by way of additional taxation, save the carbon emissions tax on new vehicles and the pending review of the level of excise duties. However, tax increases are on their way.

The rand and forex controls

As expected, the Treasury confirmed it has agreed with the Reserve Bank that the central bank may “lean against the wind” during periods of rapid capital inflows by buying dollars and that government has committed to further relaxing exchange controls to encourage two-way flows in the currency to temper the rand’s volatility.

It also kept the inflation targeting range in place, while allowing for inflation to “deviate from the target in event of such shocks”. The Bank will, however, have to explain to the public how long it will take to bring inflation back into the target range.