Many were surprised by the projected budget surplus for the next fiscal year of 0,5% of gross domestic product (GDP), announced in the Medium-Term Budget Policy Statement on Wednesday this week. One of the debates that are now raging is whether the government’s fiscal policy is more on the loose or the tight side.
“Conventional fiscal wisdom since Keynes has maintained that government should run a counter-cyclical policy. That is, when the business cycle is on the upturn and growth and job creation are accelerating, governments should cut spending, decrease taxes and generally tighten policy.
“Conversely, when the economy slows down, governments should cut taxes, increase spending and generally stimulate economic growth through looser fiscal policy,” say analysts RLJP.
The rationale behind this is that fiscal policy should act as a shock absorber to the highs and lows of the conventional business cycle, smoothing the path of growth over the longer term and preventing sharp spikes and dips in growth that can potentially destabilise the economy.
The South African economy has been in a period of unprecedented growth since 1999, and the Treasury has simultaneously run a tight fiscal ship, paying down government debt, raising revenue and increasing the rate of expenditure relatively slowly.
“In recent years, as economic growth has been strong, government has been able to increase spending quite healthily, but has increased the rate of its tax collection even faster,” say RLJP.
“We are in a phase of accelerated government spending, with around R419-billion committed to infrastructure investment over the next three years. At the same time, revenue collection as a share of GDP has risen from around 23% in 2002/03 to almost 27% for this fiscal year and is projected to rise to over 28% for the 2007/08 fiscal year. We also have a budget surplus forecast for the next fiscal year.
“It is most unusual to have heightened levels and growth of budget expenditure not seen for decades, and at the same time have continually shrinking budget deficits and even a projected surplus,” say the analysts.
The government, having reduced its need to borrow, is expected to issue fewer bonds over the medium term.
“However, if economic conditions worsen and the government finds that it needs to increase the rate of bond issuance over the medium term, it may find that it has rendered the bond market quite illiquid and that it has not issued sufficient paper over the whole of the yield curve,” says RLJP.
The analysts say this might then exacerbate bond volatility, as investors look to longer-term paper to benchmark the value of their assets and liabilities over similar terms. With the supply of paper in the market artificially restricted, it becomes much harder to accurately reflect pricing over the medium to long term.
RLJP says the government has done a fantastic job of introducing stability and predictability to the fiscal process, and its finances are in such good shape that it has ensured that the fiscus is largely proof against external shocks and downturns.
“At the same time, government should not close itself off to the possibility of further tax reform in the years to come, so long as this does not adversely affect inflation. It must also remain vigilant in ensuring that the bond market is sufficiently liquid and that enough paper is issued to ensure that the market is able to arrive at the correct prices for longer-term debt,” concludes RLJP. — I-Net Bridge