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If it ain't broken, don't fix it

Normally the national budget that is presented to Parliament by the Minister of Finance in February each year is an extended version of the Medium Term Budget Policy Statement (MTBPS) of the previous year, filling in the detail with regard to tax changes, increases in social grants, policy changes, etc.

However, this year is bound to be different because of the drastic change in the macro-economic environment since the release of the MTBPS in October 2008 as a result of the global financial crisis.

With growth prospects having been revised downward drastically, globally as well as domestically, it is unthinkable that the budget could proceed as if nothing has changed.

We find ourselves in exceptional circumstances that require an equally exceptional response.

The starting point will of course have to be a downward revision of the growth forecast underpinning the government's revenue projections. South Africa will probably achieve a growth rate of approximately 1% in 2009, which is substantially below the MTBPS's 3% forecast.

The expectation of 4% growth in 2010 likewise needs to be revised downward.

At the time of the 2008 national budget, Government was forecasting an economic growth rate of 4.2% for 2009 and 4.6% for 2010.

The downward revision of 1.2 percentage points in the forecast for 2009 by the time the MTBPS was published resulted in a mere R7.3 billion decline in the projected consolidated revenue for the 2009/10 fiscal year.

Fortunately for Government, the negative impact on revenue projections of the lowering of the growth forecast was to some extent softened by an increase in the inflation forecast, which works to the benefit of VAT receipts and personal income tax receipts via higher salary and wage increases.

The revision of the projected revenue that is now required because of lower growth will unfortunately not enjoy this benefit. CPI inflation in 2009 will in all likelihood be lower than the 6.2% forecast in the MTBPS, and the total wage and salary bill will be reduced by increased unemployment.

Revenue projections therefore need to be reduced by more than the R7.3 billion adjustment in the MTBPS, say R10-15 billion.

Assuming no change in spending plans, the revised revenue projections will lift the budget deficit from an estimated 1.6% of GDP at the time of the MTBPS to 2.1%, but the downward revision of the denominator (nominal GDP) in calculating this ratio will push it up a touch more.

There will therefore be only limited leeway for introducing a special fiscal stimulatory package as has been mooted, and any measures taken should be carefully chosen not to further undermine the already precarious balance of payments situation.

They should also not upset the longer-term strategic thrust of fiscal policy.
 
But perhaps the starting point should be to question the need for further fiscal stimulus in principle, given what is already in the pipeline:

• South Africa's business cycle peaked in Q4 2006 already, and in the two years since we have seen a swing in the budget balance from a surplus of 1.3% of GDP in 2007/08 to a projected deficit of 1.6% of GDP in 2009/10, i.e. a swing of almost 3% of GDP, which will tend towards 3.5% if the budget is revised as discussed above. This is already a massive fiscal stimulus that dwarfs the packages recently announced by a number of countries.
• The weakening in the exchange rate of the rand should lend strong support to the economy. Since peaking in 2006, the nominal effective exchange rate of the rand has depreciated by 42% and the real effective exchange rate by 26%. However, to successfully exploit the advantages of a more competitive currency in a global environment of contracting foreign trade, businesses will have to guard against the advantage being whittled away by rising production costs.
• It is almost a fait accompli that interest rates will decline substantially during 2009, probably by approximately 3 percentage points in total, starting this week. The widely expected sharp fall in inflation in January 2009, together with mounting evidence of economic weakness and job losses, creates an opportunity to front load the anticipated decline in interest rates. A number of sequential cuts of 100 basis points each in the repo rate appear fully justifiable.

Fears of igniting a new credit boom are to my mind exaggerated. Household debt and debt service costs will remain uncomfortably high for some time still - the previous upward leg of the credit cycle only started after debt-servicing costs had fallen by 7 percentage points.

Furthermore, this will be the first easing cycle since the adoption of the National Credit Act, which will surely act as a constraint on credit creation.

And then the banks are in no mood to aggressively expand the asset side of their balance sheets, as indicated by repeated media reports on the tightening of lending standards.

So what should the Minister of Finance do in the upcoming national budget?

• He can be forgiven if he starts out on a self-congratulatory note, pointing out the validity of the cautious approach adopted in recent years and reminding his detractors of the timeliness of the introduction of the structural budget balance as a more complete measure of the stance of fiscal policy.
• While he should refrain from overly aggressive stimulatory policies, he should also not be shy to add a little bit (1% of GDP?) to the expansionary thrust that is already in the pipeline in view of the exceptional circumstances with which we are faced. It would in particular be completely in order to lighten the burden of those who will bear the brunt of the deteriorating economic situation.
• He should avoid tampering with tax rates - these should only be adjusted as part of a comprehensive and well-designed programme of tax reform and not opportunistically. If any stimulus is to be provided via the revenue side of the budget, it should be by way of a once-off tax rebate.
• Any additional spending should likewise take place in the context of the Medium Term Expenditure Framework (MTEF) and should not upset the hard-won gains in discipline of recent years. However, in so far as the MTEF already allows for an expansion of social grants, specifically the child grant and social old-age pension for men, it will not be inappropriate to bring forward some of the extensions planned for the future. While unemployment benefits in South Africa are conservative in extent and act as an extremely effective automatic stabiliser to the economy, any extension in this regard should be carefully considered for its long-term sustainability as it will be difficult to reverse.
• While increased spending on neglected infrastructure forms a substantial part of current fiscal packages around the world, this option is probably not open to South Africa as we have already reached the limit in our capacity to implement such projects.

But perhaps the most important requirement for the upcoming national budget is to reassure the relevant parties of the parameters within which fiscal policy will be conducted in future, in view of the concern regarding policy continuity after the upcoming general election.

There is a simple rule that can fruitfully be applied to South Africa's fiscal management: if it ain't broken, don't fix it.

Jac Laubscher is the Sanlam Group Economist.