Budget 2003/04 Hearings: 6 March 2003
Portfolio Committee on Finance
Comment from the Afrikaanse Handelsinstituut

The government’s national budget for 2003/4 is a reflection of sound fiscal management and a strong economy, while still making good political sense.
The overall drive of the measures presented in the budget is supportive of economic growth, job creation and poverty relief in South Africa. A general impression of the budget is one of targeted increased spending on critical areas (such as poverty relief, crime fighting, education, health care, infrastructure, roads and hospitals), tax consolidation measures and granting moderate relief for new and small business incentives.
The increased expenditure together with tax relief measures, have been made possible by overruns in budgeted revenue and declining debt financing costs.

From a macro-economic outlook the following was noted:
Household consumption expenditure
should receive a boost from the large cut in personal taxes and the real increase in social grants. As nearly 60% of the personal tax cut is aimed at taxpayers with an annual income below R150 000; the positive implications should be spread over all categories of consumption expenditure. The budget should also have a positive impact on consumer confidence, thus contributing to consumption expenditure later in the year.
Fixed investment spending should also benefit from the budget. The biggest benefit should come from the budgeted increase in government investment (especially in infrastructure), the continued accelerated investment allowances for manufacturing and the new depreciation allowance for small businesses. Corporate tax rates have, however, not been adjusted. The measures announced to relieve the tax burden on savings and fixed capital formation are to be welcomed. South Africa's low savings propensity and equally low level of fixed investment intensity (capital formation / GDP), have long been singled out as impediments towards increasing the economic growth rate above the 3% level on a sustainable basis.
The impact of the budget on inflation should be relatively small, however the increases in the government wage bill (at 10% well above the expected average inflation rate for the year) and the positive impact on the demand for goods and services should both put some upward pressure on inflation. This would imply a slower decline in inflation during the year rather than an increase. The fact that the target for 2005 has been put at 3 – 6% and not 3 – 5% takes account of this element.
The implications of the budget for interest rates are mixed. The inflation target for 2005 of 3 – 6% implies less pressure on the Reserve Bank to keep interest rates high. However, the increase in the deficit and the generally positive implications for domestic demand suggest some upward pressure. In sum the implications of the budget for interest rates are limited and should not derail the expected decline in the prime overdraft rate from June onwards.
The effect of the budget on the exchange rate is less easy to predict. The impact of the exchange control changes, particularly those concerning the limits on the foreign investment of financial institutions and the blocked rand balances, should result in an outflow of funds and thus put downward pressure on the external value of the rand. The announced foreign exchange amnesty - the repatriation of "grey money" - could result in an inflow of funds, however it might not balance the expected outflow of funds. The exchange control concessions are not expected to lead to a sudden flood of money leaving the country, but on balance one should expect a period of increased outflows while people adjust to the new measures, lending a depreciating bias to the rand in the absence of any countervailing long-term capital inflows. In the medium-term, however, the rand should benefit from greater encouragement of two-way flows in the foreign exchange market.
The overall impact on economic growth should be positive.

From a business perspective, the following announcements are welcomed:
Foreign dividend tax relief on subsidiaries;
Liberalisation of exchange control measures;
Reduction of the tax on retirement funds from 25% to 18%;
Raising the tax thresholds and extending the tax brackets for individual taxpayers;
Accelerated and new depreciation allowances, including new relief measures for research and development cost;
Reducing excise duties on passenger vehicles and computers;
Further relief measures for small business enterprises;

Other noteworthy items in the budget are:
Projected increases in real spending of 6,8% (2003) and 4,5% for the next two years
An increase in the child support grant to R160 per month and a 3-year extension of the qualifying age groups
Pension and disability grants to increase to R700 per month
Specified increases for police, universities and technicons, land restitution and administrative systems and SARS
Increased infrastructure investment and public works programmes
A R10 bn fund for black economic empowerment
An increase in the deficit before borrowing from the (estimated) 1,4% of GDP for 2002/3 to 2,4% for 2003/4

Main threats and risks to the budget outcome.
The main threats for the South Africa economy in general and the budget in particular, are perceived as external; - a protracted war in Iraq, a war-related surge in oil prices, increased terrorist activity in Europe and North America as a result of conflict in Iraq, and a global slowdown in economic activity. However, two different domestic threats are emerging:
The "structural" tendency for faster growth in South African GDP could spill over into excessive imports, thereby pushing the rand down and inflation up.
The overvaluation of the rand. The major impetus to growth in the South African economy in the past two years has been exports and export-related investment. If export growth slackens because of a strong rand at just the moment when the government is fuelling domestic consumer spending via tax cuts and increased public expenditure, the gains of the recent past could well be jeopardised. Against the background of depressed international economic growth prospects, affecting South African exports and therefore domestic growth, this could impact negatively on the projected revenue growth in the budget.
These are genuine threats, but for the time being the economic picture looks comparatively optimistic.

Measuring the effectiveness of economic policy
At macroeconomic level five major macro-economic principals are normally used to evaluate monetary and fiscal policy, in this instance the budget 2003/04.
Economic growth and economic development
The ultimate aim of economic policy is to improve wealth per capita of the population in the long term.
The macroeconomic impact of the budget is growth stimulating. After a very sluggish growth performance averaging 2.7% a year since 1994, the economy appears to have broken through the 3% threshold, with Mr Manuel forecasting expansion of 3.3% this year, accelerating to 3.7% in 2004 and 4% in 2005. The South African economy has proved quite resilient over the past few years and the measures presented in the budget are generally aimed at supporting this and at enhancing the growth rate on a sustained basis.
Full Employment
Unemployment is one of the biggest problems in South Africa and can only be improved by sustainable economic growth over the long term.
Job creation is more present in this budget than ever before The first feature in the budget is the provision for more infrastructure spending by municipalities and secondly the skills and development strategy. Besides certain programmes the budget also puts emphasis on job creation in policy on black empowerment, tax incentives and redistribution of land backed by agricultural support, however the minister steered clear of a populist approach
Price Stability
Another goal of an economic policy is to maintain a relatively stable level of prices over a period of time without excessive inflation.
As far as inflation is concerned, the impact of the budget should be relatively small. The budget’s inflation forecast for CPIX is 7,7%, which is not far from the current market consensus.
Balance of Payments stability
The stability of the balance of payments depends on investor's confidence and consequently on sound economic policies and a stable political and macro economic environment not only in South Africa but also in the sub-region. International competitiveness is the norm for success in the world economy.
In this regard the budget presents a friendlier package for investors, both international and local, big and small. Changes in corporate tax regime aim at encouraging investment, research and development and further stimulation of small and medium -sized businesses. Further announcements enhancing South Africa's overall international attractiveness and relative competitiveness include;
Tax allowances for upgrading decaying areas
A strong upswing in infrastructure spending to 6% of GDP
More spending on police, with the police budget rising with 11,5%
Exchange control relaxation. Foreign investors do not like exchange controls. The foreign investment limit by SA companies' abroad is raised to R1 bn and the repatriation of dividends from offshore investments will enhance SA businesses' role in the international economy.
Fair distribution of income
The distribution of income among individuals, groups, sectors regions and countries has a critical impact on the tempo, nature and geographic distribution of economic growth and development.
The urgency of social needs is self-evident. In this regard the minister of Finance effectively balanced the political imperatives. On the one hand the reduction in personal income and the beneficial recalculation if depreciation allowances to spark city-centre rejuvenation. Renewed focus on education and health assists in creating a sustained generator for economic growth. On the other hand the minister gave to the poor. The budget has begun to construct a social security net for the poor through the allocation of new grants, a bigger school nutrition programme, food and education aid and effective increases to fund basic electricity and water provision.

A small business perspective on the 2003/04 budget

Small businesses are as dependent as big business on general economic conditions for their success. The generally positive macroeconomic implications of the budget are therefore to be welcomed, especially the positive impact the budget will have on economic growth in the short as well as the long term. The general business stimulus measures that were announced will also create opportunities for small businesses, e.g small contractors will benefit from the incentives for refurbishment of buildings in designated urban areas.

We welcome the measures announced in the budget that will specifically benefit small businesses:

The enlargement of the category of small businesses qualifying for the graduated tax rate of 15% on the first R150 000 of taxable income to include businesses with a turnover of up to R5 million per year (previously R3 million) will allow companies in lower margin types of business to also benefit from this dispensation. We nevertheless believe that the aim should remain to increase the R150 000 taxable income ceiling – it should at least be adjusted annually for inflation to preserve the real value of this benefit.
The measure to allow a double deduction for the first R20 000 in start-up expenses for a new business will assist small businesses in dealing with the initial negative cash flow of a new venture. The size of the deduction can however be questioned. While it may provide meaningful relief to small businesses that are not capital intensive (e.g. in the services sector), it will be less beneficial for businesses in the manufacturing sector. We believe that one of the challenges in small business development is also to encourage small manufacturing companies, producing for the local market as well as for export.


Conclusion:
It is probably unwise to read too much into the muted market response to the budget. In the current nervous global environment, gold, the rand, the dollar and events at the United Nations Security Council will move world markets, but this should not skew perceptions of what was essentially a highly technical and professional budget.



Jac Laubscher

Anne-Marie Whiehan

On behalf of the Afrikaanse Handelsinstituut.

6 March 2003