Spend, baby, spend

Increased government spending, especially on infrastructure, will provide the economy with some support during the anticipated global economic downturn.

The government has allocated an additional R170-billion to spending over the next three years, and next year state spending will jump to 29% of GDP from 27,5%.

Government will take over from the private sector as the driver of economic growth locally and possibly cushion the blow of the global economic slowdown. In his medium-term budget policy address Finance Minister Trevor Manuel said the role of fiscal policy is to smooth out the boom and bust economic cycles. The days of budget surpluses are over — next year Manuel will be dipping into the overdraft and South Africa is expected to run a budget deficit of 1,6% of GDP.

According to the medium-term budget, South Africa’s growth forecasts have been reduced to 3% next year, but we will not enter a recession. Although growth in consumer expenditure will be negligible, at about 1,6% next year, treasury estimates that real growth in fixed investment will average 9% a year over the medium term.

Gross fixed capital formation by general government and public enterprises will increase by 14,2% a year in real terms. This will be driven by the R600-billion committed to infrastructure development in the next three years, of which R60-billion will go to Eskom.

While the expenditure on fixed investments will support economic growth, it is not clear what effect it will have on job creation. Despite a pool of five million unemployed people, South Africa is still short of semi-skilled workers. In an interview with the Mail & Guardian Manuel said South Africa has to import artisan skills such as welders. If government is to meet its aim of halving unemployment by 2014, much must be done to develop these skills. Manuel said that while it is understandable to have a skills shortage in highly skilled professions, a shortage of artisans is a failure of the country to develop basic skills and constrains economic growth.

Funding for fixed investment has become less accessible given the global financial crisis. Government will support investment programmes by strengthening the role of development finance institutions, such as the Industrial Development Corporation and Development Bank, in financing infrastructure projects. Manuel said these institutions have the capacity to raise capital at rates close to South Africa’s sovereign debt.

South Africans will have to adjust to higher utility costs for utility providers to recoup costs. Treasury’s director general, Lesetja Kganyago, said that South Africans will need to pay more for their utilities even though government has cushioned the impact on consumers by providing Eskom with upfront funding for infrastructure development. Eskom will not be required to pay interest in the first 10 years of the 30-year loan. Government will also provide guarantees for key projects to access capital markets at better rates.

Although funding may be tighter, South Africa does have the capacity to borrow extensively. Government debt is 25% of GDP, half the level it was in 1998 and well below the 60% maximum debt levels recommended by the International Monetary Fund. Costs of servicing the debt have also fallen in the past 10 years from 6% of GDP to 2%. Treasury says that the R600-billion will come from a mix of local and international funders. Global funding for emerging markets has become excessively expensive during this crisis but treasury says Eskom has spoken to the World Bank and the African Development Bank and there will be access to export finance at good rates. There is an appetite for government debt in the local market with bond yields trading below 10%.

Any spending spree comes at a cost and for South Africa that will be the current account deficit, which is expected to increase to 8,9% of GDP in 2010.

Manuel said that the account deficit “is worrisome and remains a concern”. The deficit will maintain pressure on the rand, which Manuel argues acts as a shock absorber for the economy by reducing the demand for imports and increasing exports. This should in theory bring the account deficit to more manageable levels in the longer term.

But there are problems with this simplistic approach. Although a more competitive currency should bolster exports, a global slowdown will mean less demand for our exports. As part of the ongoing capital expansion programme, South Africa will be required to import its major capital requirements and a weaker rand will make this more expensive. This year portfolio investment flows, which help South Africa pay for our imports, have dried up as a result of the crisis.

The only real long-term solution to our trade deficit is an increase in local savings. Our lack of savings is what sets us apart from Asian emerging markets, which have high levels of savings. South Africa relies on the savings of other nations into local assets to offset our deficit. The global meltdown has meant a flight to safety and South Africa will have to turn to its own population for savings.

Manuel suggested that this could be done through a compulsory savings scheme. These measures have been adopted in other emerging countries like Chile, which required higher savings rates to boost local investment.

Inflation on target in ’09
The medium-term budget policy statement forecasts inflation to return to target in the third quarter of 2009. This is in contrast to the Reserve Bank’s recent estimate that it would come back into the range only in 2010. Economists believe the medium-term budget estimates are optimistic.

But Finance Minister Trevor Manuel said that, given the sharp drop in the oil price, the next quarterly review issued by the Reserve Bank is likely to show inflation falling faster. The medium-term budget has inflation at 6,5% for 2009. This is mostly driven by the change in the inflation basket. From January the basket will be reweighted and property rentals will be included. This will result in a sharp drop in the inflation figure.

But an early interest rate cut is not likely as the Reserve Bank continues to focus on inflation. In an interview Manuel argued that the downturn in interest rates globally will be short-lived and is purely a measure to bring liquidity into the economy. He says inflation remains a global concern and negative interest rates, such as in the US, create a disincentive to save. South Africa’s high inflation rate, which is double the target range, will cost taxpayers R59-billion in budgeted inflation adjustments for salaries, social grants, increased fuel costs, medicine, food and textbooks.

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Maya Fisher French
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