A ballooning deficit

Just as President Barack Obama was rudely reminded of the enormous task ahead of him when United States markets fell 5% (their biggest drop since December 1) on the day of his inauguration, so South Africa’s leaders will have to face the stark reality of how to finance promises made during ­elections.

This year South Africa is likely to face a budget deficit of between 4% and 6% of GDP as revenue falls and expenditure rises. It is also likely that the budget deficit for the year will be revised to show at least a R25-billion (1,5%) budget deficit compared to the stated R14,3-billion budget surplus in last year’s budget address.

In this year’s budget, to be delivered on February 11, Finance Minister Trevor Manuel is unlikely to provide much tax relief to taxpayers as the focus will be on expenditure to stimulate the economy rather than on consumption. Falling interest rates is the only relief consumers can look forward to this year.

Based on global experience countries are not advised to run budget deficits in excess of 3% of GDP. Some economists expect Manuel to err on the side of caution, especially if this is his swan song.

Stanlib economist Kevin Lings says he believes the minister will not present a deficit of more than 3% of GDP but that this could be revised later in the year, possibly when revenue collections fall short.

“The overall message [from the budget] would then be that government has to make choices, especially on expenditure priorities,” says Lings.

But Manuel may not have much of a choice. Based on a commitment to increase expenditure 16% and revenue shortfalls of R15-billion to date, Manuel will face a widening gap between expenditure commitments and declining revenue, especially from VAT collections.

The latest revenue figures show that VAT, the fuel levy, customs duties, transfer duties and personal income tax are all well behind budget as people cut spending and job losses start to affect income tax.

Corporate tax is ahead of budget but, because of the annual nature of company taxes, this has not yet reflected the worsening economic situation and company taxes should start to fall significantly.

Revenue for next year is likely to grow at single-digit figures after years of double-digit growth that has enabled the state to beef up expenditure, including infrastructure and social grants, while providing taxpayers with significant relief.

If revenue grows at 7%, the budget deficit, based on the 16% increase in expenditure, will grow to 4% of GDP. Should South Africa enter a severe recession and revenues become significantly weaker, at 3%, for example, we could see the deficit rise to 6% of GDP by year end.

In this mix Manuel will need to lower taxes to adjust for bracket creep as well as demands from his own party to meet the promises of the ANC election manifesto.

Given the economic crisis it would be unlikely that a deficit of 6% would be penalised by investors, considering the US’s budget deficit is expected to exceed 10% of GDP. The key for South Africa will be how the money raised by this debt, which will be paid for by our children, is used.

The deficit figure is not as important as how the money is spent. Areas that are likely to receive support are infrastructure, support for Eskom, the fight against crime, World Cup 2010, skills development, education and healthcare.

But there needs to be more emphasis on what is actually being delivered per rand spent. Recommendations to Parliament for greater oversight of and accountability by departments are welcomed and it is hoped that — if this is indeed Manuel’s final budget address — whoever replaces him will also insist that departments provide business plans before money is allocated.

South Africa’s biggest expenditure is on education, yet only a third of children complete their education in 12 years and their lack of skills hinders economic growth. Compared to other emerging countries, South Africa is one of the biggest spenders on education and health when compared to GDP, yet we do not get the desired results.

It is likely that in his address Manuel will again stress the importance of an efficient allocation of resources, especially at a time when there is a lot less to go around.

How to stimulate the economy
One could argue that South Africa has been in an economic crisis for a long time. We don’t question unemployment rates of 23%, while the US slashed interest rates to almost zero and the Obama administration is planning $775-billion in fiscal spending as US unemployment levels sit at an unexpectedly high rate of 7,2%.

United Kingdom interest rates have now been cut to 1,5% with further cuts mooted as unemployment breached 6%. Last week the UK announced an additional fiscal package aimed at medium and smaller-sized businesses.

The South African government, however, has shown an inability to use money effectively with expenditure running behind budget because of inefficiencies and skills shortages at delivery level.

Rather than running high budget deficits with little bang for the buck, South Africa should look to a monetary response.

Unlike many other countries we have a lot to play with on the monetary policy side. But we must bear in mind that a fiscal response tends to feed into the economy quicker and key infrastructure projects are needed if South Africa is to build a platform that can deliver higher growth in the future.

As Moody’s Economy.com highlighted in its latest report, rising joblessness is a major threat to South Africa’s outlook, with unemployment already running at an estimated quarter of the labour force.

“The weaker employment outlook and mounting concerns about future income streams are expected to further restrain consumer spending in the coming months.” The report says the outlook for South Africa’s economy has worsened since the rate cut in December and that pressure is now on the Reserve Bank to cut rates by 100 basis points in February.

Lings says, apart from spending more wisely, government needs to build business confidence ahead of 2010 so that it retains staff. “If business is confident that 2010 will see a recovery then they will be more inclined to hold on to staff in anticipation of a recovery, rather than retrench now.”

Lings says a 100 basis point cut in rates would get that message across. He says confidence can also be built by using the World Cup as an energy point to improve confidence and showcase South Africa’s capabilities. The Zimbabwe crisis also needs to end.

A lesson from the US, Lings says, is its Conference of Mayors report, which details an initiative in which cities and towns must identify small, job-creating infrastructural projects that can begin within two to three months and can be completed within 18 months. This will be coordinated by central government through a special fund.

Although not Reserve Bank policy, exchange rates could also be used to alleviate unemployment.

Investec strategist Michael Power says South Africa should allow a more competitive exchange rate. This would create demand for our products, which would become relatively cheaper to both a domestic market — which would find imported goods too expensive — and to the international market — which would find its dollars or euros going further against a weaker rand. This would create jobs locally and start to put a dent in the unemployment rate.

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Maya Fisher French
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