REPORT ON THE MEDIUM TERM BUDGET POLICY STATEMENT 2004

The Portfolio Committee on Finance is mandated to interrogate and report to the National Assembly on the macro-economic issues raised in and by annual Medium Term Budget Policy Statements. The present report refers to the Committee's work on the 2004 Medium Term Budget Policy Statement (MTBPS) tabled before Parliament by the Minister of Finance on 26 October.


In addition to studying the Minister's speech and supporting documentation, the Portfolio Committee, together with the NCOP Select Committee on Finance and the Joint Budget Committee, was further briefed by the Minister, the Director General and other officials of the National Treasury on October 27. A further joint meeting was held on October 29 to hear the views of a panel of commentators, including two economists linked to a merchant bank and parastatal corporation respectively and a researcher from IDASA's Budget Information Service specializing on gender budget issues.


1: MTBPS PERSPECTIVES ON MACROECONOMIC PERFORMANCE AND FORECASTS

The 2004 MTBPS is tabled against the background of a significant improvement in the performance of the South African economy. After a cyclical slowdown in 2003, when the growth in the real Gross Domestic Product (GDP) fell to around 2%, GDP growth increased to an annualized rate of 3,3% in the first half of 2004. The Medium Term Expenditure Framework (MTEF) for 2005/6 to 2007/8 anticipates further broad based economic expansion with real GDP growth expected to average 4% over the three year period.


CPIX inflation remains subdued at a level of 4.4% for 2004. This is despite a significant increase in the international price of oil. Although there remains a risk of further significant international oil price hikes, the MTBPS anticipates inflation remaining within the target range of between 3-6%, but is expected to rise slightly from the current level to 5.1% by 2007. The generally low inflation environment has created conditions for a decline in interest rates taking real interest rates to their lowest level for around 30 years.


The recent appreciation in the exchange value of the Rand (which rose by 8,2% during the first half of 2004) is seen as deriving mainly from the weaker dollar, the favourable interest rate differential between South Africa and its trading partners and the buoyancy of commodity prices. While the stronger Rand has negatively affected some export and import competing sectors, it has also contributed largely to lower inflation and cushioned the potentially negative impact on growth of the sharp increase in the US $ price of oil.


The MTBPS further reports that the combination of the stronger currency and the improved growth prospects have led to stepped up expenditure by local firms on equipment. Real gross capital formation rose by 8,5% year on year in the first half of 2004.


The combination of an overall growth in imports, of certain large contractual obligations associated with defence procurement and acquisition of civilian aircraft, and of the rise in the oil price has led to a widening of the deficit on the current account of the Balance of Payments to 3,8% of GDP in the second quarter of 2004. For 2004 as a whole the current account deficit is expected to average 2.4% of GDP. The MTEF anticipates this annual average rising to 2.8% of GDP in 2007. However, steady financial inflows, recorded in the capital account, have led to a surplus in the overall Balance of Payments (BOP) this year. This has allowed the South African Reserve Bank to buildup its foreign exchange reserves, which stood at $ 12,2 billion at the end of September 2004. Short term debt cover rose to 340% in the first half of 2004, compared to 126% in 2003. Import cover now stands at 21 weeks compared to an average of 19.5 weeks between 2002 ans 2003.


Some indication of a possible turnaround in employment prospects is reported in the MTBPS. Stats SA's labour force survey in March 2004 points to an increase in employment by 419 000 since March 2003. The unemployment rate is reported, as a consequence, to have decreased from 31% to 28% over the same period, although the relevant underlying statistics are subject to uncertainty. As indicated above, gross fixed capital formation has expanded over the past 19 quarters and grew by 8.5% year-on-year in the first half of 2004. Investment by private businesses was the main source of this growth. Government policy aims to increase the overall rate of capital formation from the present level of 16% of GDP to 25% of GDP by 2014. To this end, government itself will increase its contribution to fixed capital formation by undertaking major investments in roads, rail and ports infrastructure, electricity infrastructure, sporting infrastructure for 2010 soccer world cup and several major water schemes. Investments in more efficient communication and information technology as well as housing and community services will also be promoted. Increasing the level of foreign direct investment is identified as an important challenge, although the MTBPS reports that portfolio investments are high. In the first half of 2004 non-residents acquired R17.8 billion of South Africa's portfolio assets while FDI decreased by R3.2 billion.


Global recovery is reported to have strengthened in the first half of 2004 reflecting the strength of upturns in both China and the United States. The IMFs World Economic Outlook anticipates growth in the world economy at 5% for 2004. This has been one of the main factors underlying a strengthening of commodity prices that has supported both the Rand's strength and South Africa's economic recovery going forward. Gross domestic expenditure (GDE) rose by 5.7% in the first half of 2004 responding to a strong Rand and falling interest rates. This is one of the major factors contributing to an increasing current account deficit in the first half of the year. Household consumption expenditure is also strengthening as a result of a decline in interest rates and tax relief in the past few years. Household consumption expenditure increased by 4.4% in the second quarter and by 4% in the first quarter of 2004.


2.
THE FISCAL FRAMEWORK

2.1 Expenditure Trends

The MTBPS re-states government's commitment to a policy framework that supports economic growth and development and the same time advances human development and reduces poverty. The improved performance of the South African economy is seen as providing government with an opportunity to increase expenditure in delivering public services without undermining overall macro-economic stability.


Real growth in non-interest spending is projected to increase by 6,5% in 2005/06, and by an annual average of 4,3% over the MTEF period. The budget deficit is expected to increase from 3,2% in the current year to reach 3,5% of GDP in 2005/06 before declining to 2,7% by 2007/8.. General government borrowing for 2004/5 rises from the budgeted 3,3% to 4,1% of GDP. It is anticipated to rise to 4,4% in 2005/6 before falling to below 4% in the outer two years of the MTEF.


Other key trends over the MTEF period include the following:

Over the MTEF period, the government intends to increase public sector expenditure on capital and infrastructure from the estimated 5,5% of GDP in 2004/5 to 6,5% by 2007/8. The total expenditure by national, provincial and local governments as well as public enterprises is projected to rise from R 73,5 billion in 2004/5 to R 113,5 billion by 2007/8. This will be financed both by budgetary allocations and off budget operations.


2.2
Taxation and Revenue

Policy measures announced in the 2004 Budget and given effect in Revenue Laws Amendment Bill (B22- 2004) include:

Tightening of anti-avoidance measures on executive equity schemes and hybrid arrangements;

Tax relief for broad-based employee share ownership programmes;

Tax relief for investments in South Africa by persons within the Common Monetary Area.


The MTBPS indicates that tax proposal in the 2005 Budget will focus on simplifying tax compliance for small enterprises, revised tax treatment of health care benefits and motor vehicle allowances and amendments to facilitate the hosting of the FIFA World Cup in 2010. No major personal tax cuts are anticipated in the 2005 budget.


Revenue projections for 2004/05 are revised upward by Rl,2 billion bringing total anticipated revenue collection to R328,2 billion.


3.
PANEL DISCUSSION

Three commentators were invited to make presentations to a joint Committee meeting on October 29. Two were economists attached to a private merchant bank and a parastatal respectively and one a specialist on gender budget issues. A research institution attached to the labour movement withdrew at a late stage.

In general the panelists agreed on the following:


1. The overall expansionary fiscal stance is both welcome and appropriate. It is also well within parameters of sustainability and fiscal prudence.


2. The GDP growth projections in the MTBPS are realistic and attainable. One of the panelists, Prof. Brian Kantor, however, added the rider that this depended on there being no major exchange rate shock. He also expressed the view that growth as high as 5% or 6% would be attainable if investment reached the 25% of GDP target.


3. The relaxation of foreign exchange controls announced in the MTBPS (viz the abolition of financial limits on foreign direct investments by South African corporates) do not pose any major risk, at least as long as relative exchange rate stability and growth persist.


Beyond this, two of the panelists, Mr Mandia Maleka of Eskom and Ms Penny Parenzee of idasa, emphasized the need for expenditure programmes more effectively to address structural problems confronting people trapped in the "second economy" for whom growth in the "first economy", or the economy as a whole, would not automatically translate into improved prospects for higher incomes or sustainable livelihoods. Ms Parenzee argued that public works programmes provided only a short term solution and that there was a need to re-focus the debate on increasing investment more towards investments that would promote household based production and reproduction. She also argued for a more adequate consideration of the gender dimensions of poverty and unemployment. Prof. Kantor, on the other hand, emphasized increasing the growth rate largely through activities within the "formal" economy. He argued that for investments and savings to reach the target of 25% of GDP, there should be a reduction in corporate tax and a corresponding increase in expenditure taxes. There was no consensus among the Committee on these matters.


4.
CONCLUSION

Taking into account the above, as well as the thrust of most public commentaries on the macro-economic dimension of the 2004 MTBPS, the Committee concludes as follows:

The overall expansionary fiscal stance envisaged over the MTEF period is appropriate and necessary to give further impetus to economic growth and development.

The additional allocation ofR50 billion over the previous baseline estimate and the projected increase in public infrastructure spending (from 5,5% to 6,5% of GDP) will allow important programmes to make more of an impact. There is, however, some concern that over the first two years of the MTEF, at least, most of the former will be on consumption rather than capital expenditure.

The expansionary fiscal stance is well within parameters of sustainability and prudence: the small increase in the budget deficit poses no serious risk.

The growth projections underlying the MTEF are realistic and attainable. They do not depend on unrealistic assumptions about the performance of the world economy. Most of the risks to the growth projections arise from potential external shocks (oil price or exchange rate instability) which do not appear likely to have major destabilizing effects at this stage.

There is a need for more information on the expected impact on employment of the projections in the MTBPS; including both the expected impact of an increase in the growth rate to 4% and, since much of the unemployment is structural in nature, of the projected expanded infrastructure programme.

While most commentators see little risk from the exchange control relaxations announced in the MTBPS, the Committee believes that the remaining application requirements, including demonstrating to the Reserve Bank that a foreign direct investment has a "demonstrated benefit to South Africa", must be strictly enforced. The Reserve Bank's reserved right to stagger any capital outflows is

also important

The Minister's concern that "A sustainable social security system must balance bringing in everyone who is entitled to grants and keeping out everyone who is not entitled to them", is understandable. However, the Committee earnestly hopes that efforts to deal with mismanagement and fraud do not inadvertently result in a raising of the bureaucratic bar in ways that disadvantage poor households that should be receiving grants.


Report to be considered.