Report of the Portfolio Committee on Finance on the 2008 Medium Term Budget Policy Statement (MTBPS), dated 17 November 2008

Report of the Portfolio Committee on Finance on the 2008 Medium Term Budget Policy Statement (MTBPS), dated 17 November 2008.

1. Introduction

The Minister of Finance (“the Minister”) tabled the Medium Term Budget Policy Statement (MTBPS) before Parliament on 21 October 2008. In tabling the MTBPS, Government met its obligation under section 28 of the Public Finance Management Act (PFMA) that requires the National Treasury to table multi-year budget projections for revenue, expenditure and key macro-economic projections on an annual basis. The Portfolio Committee on Finance (“the Committee”) is mandated to consider and report on the MTBPS with the exception of those sections dealing with the medium-term budget priorities and the division of revenue. The Committee therefore deliberates on the macro-economic outlook, fiscal policy and revenue trends.

Following the tabling of the MTBPS and the engagement with the Minister and the National Treasury, the Committee held public hearings on 24 October 2008 receiving submissions from a panel of economists, organised business and organised labour. This report reflects the main themes emerging from the engagement with the Minister and the National Treasury, as well as the input of the economists, organised business and organised labour. The report consists of three sections. Section 2 gives an overview of economic policy and outlook with specific reference to key macro economic indicators within the context of the current global economic environment. Section 3 provides details of fiscal policy over the next Medium-Term Expenditure Framework (MTEF) with specific reference to the fiscal stance adopted by government. Section 4 gives a summary of some of the selected aspects regarding budgeted revenue as well as key tax/revenue reforms which accompanied the tabling of the MTBPS.

2. Economic outlook and policy

The MTBPS provides the framework on which the 2009 Budget is to be constructed. The policy statement provides all stakeholders with an ideal opportunity for broad public discussion of, and engagement with, longer-term trends in economic policy. Essentially, the MTBPS is making “public” the MTEF. It is important to note that the MTBPS is neither a budget nor what people commonly refer to as a mini-budget. The MTBPS gives an indication of government’s assessment of the following:

Ø The state of the economy;

Ø The fiscal framework;

Ø The budget priorities; and

Ø The division of revenue between national, provincial and local government.

In other words, through an assessment of the above, the National Treasury is able to pave the way for the next MTEF. The tabling of the MTBPS came amidst a global financial crisis which affects developed, developing and emerging countries. Laubscher[1] pointed out that the global financial crisis is indicative of a recession. According to Laubscher, developed countries are set to go through a classical recession which is characterised by two consecutive quarters of negative growth, while in developing countries, the recession will be characterised by a growth recession – a growth recession in essence means that there will still be positive growth but at a much lower rate.

Since the tabling of the National Budget in February 2008, the global economic context has changed considerably. At the time of the tabling of the National Budget, the degree of economic uncertainty was not as severe, and the prospects for global growth were still reasonable. The view of the National Treasury is that because of early decisions on fiscal policy, inflation targeting, the gradual approach to exchange controls, banking regulation and public spending choices, South Africa will be able to weather the financial storm. Despite these fundamentals being in place, the National Treasury made the point that the global financial crisis will indeed affect the trajectory of the South African economy.

National Treasury (2008) highlighted the following two scenarios for the South African economy in the midst of the global financial crisis:

Ø The crisis that emerged in the developed world will result in a reduction in international trade, with a concomitant decline in economic growth in the emerging markets and continuing financial volatility – the implications for South Africa would be a prolonged period of much slower growth coupled with real income and corporate profits coming under pressure; and

Ø Greater international policy coordination and improved regulatory capacity to intervene in poorly performing markets will result in a period of global economic adjustments over the medium-term, followed by more balanced growth.

In response to these two scenarios, the National Treasury has formulated economic policy as follows:

Ø The formulation of fiscal policy to offset short-term economic slowdown while maintaining a positive saving rate; and

Ø The formulation of monetary policy to support the rebuilding of household savings in the short-term, manage inflation expectations and support capital inflows.[2]

Laubscher is of the opinion that the MTBPS is based on the second more optimistic view – one benign to developing and emerging markets. Ballim[3] pointed out the current economic turmoil has resulted in demand globally being under threat, while in South Africa, there has been a sharp interruption in the secular growth trend. FEDUSA[4] also acknowledged the context within which the 2008 MTBPS was tabled by stating that the challenge from the fiscal side for the next 3 years was to counteract the adverse effects of the external factors, including the banking and credit crisis in developed countries.

FEDUSA pointed out that in the light of the global economic challenges ahead, special attention needs to be given to South Africa lifting its rate of national savings – this is necessary in order to construct a more export oriented economy, and create a more labour-intensive growth trajectory.

The 2008 Budget Review forecasted Gross Domestic Product (GDP) growth of 4.0 per cent for 2008, reaching 4.2 per cent in 2009 and 4.6 per cent in 2010, partly in response to the stimulus from the 2010 FIFA World Cup.[5] The global financial crisis has however necessitated the National Treasury to change its growth forecasts - GDP is projected to grow by about 3.7 per cent in 2008 and 3.0 per cent in 2009, before rising to 4.0 per cent in 2010 and 4.3 per cent in 2011.[6] BUSA[7] recognized this downward revision of GDP forecasts and stated that in their assessment of growth forecasts it will become necessary that the level of global volatility might require some adjustments to forecasts over the next few months.

In its presentation to the Committee following the tabling of the MTBPS, the National Treasury advanced the following as reasons for revisions to GDP:

Ø Slower global growth as industrialised and developing countries absorb the impact of the credit crisis;

Ø Declining commodity prices;

Ø Slower consumption growth due to higher than expected inflation and interest rates; and

Ø Reduced wealth effects due to falling asset prices (housing and equities).

Table 1 gives an overview of the “revised” macro-economic projections as per the 2008 MTBPS.

Table 1: Macroeconomic projections

Source: National Treasury (2008b)

According to Table 1, investment growth is projected to average about 10% over the next MTEF, rising from 8.7% in 2009 to 9.3% in 2011. National Treasury pointed out that investment growth will remain the key driver of growth over the medium term. Investment growth in 2008 has been strongest in the public sector, with the share of investment by public corporations rising to 15.3 per cent in the first half of the year from 11.3 per cent in 2003.[8] The private sector accounted for about 72 per cent of total investment in the first half of 2008.[9] BUSA pointed out that various commentators have argued that demand driven growth was not sustainable and that it was critical to focus on unlocking supply side growth. Accordingly BUSA pointed out that government’s infrastructure investment programme should provide the necessary supply side stimulation to the economy.

According to Table 1, Consumer Price Inflation (CPI) is expected to fall towards the inflation target range (3 – 6 per cent) in 2009 helped by lower food and oil prices. CPI is projected to average 6.2 per cent in 2009 and 5.3 per cent in 2010. The expected movement of CPI towards the target range is partly as a result of the introduction from January 2009, of a new target measure of inflation in the form of Headline CPI[10] for all urban areas. Through the introduction of this, South African inflation statistics will be brought in line with international best practice. New weightings for items in the basket of goods and services will also accompany the new target measure.

The current account[11] deficit is projected to average 8.3% of GDP over the MTEF. After dipping to 7.8% of GDP in 2009, it is expected to be at 8.8% of GDP in 2011. This gradual increase in the current account deficit is a reflection of South Africa’s mismatch between savings and investment. South Africa has in recent years financed its current account deficit with foreign capital inflows in the form of portfolio flows. During 2008, the largest proportion of capital inflows (not exclusively portfolio inflows) came in the form of direct investments, notably the Chinese buy-in in Standard Bank.

According to Laubscher, these portfolio inflows, commonly referred to as “hot money”, move swiftly around the world, seeking returns by trading in stocks, bonds and currencies. Laubscher further stated that in the current global financial circumstances, this way of financing the current account deficit may be a workable solution. However, the substantial withdrawal of funds from South Africa by foreign investors in recent times as a result of risk aversion in emerging markets potentially exposes the country to sharp currency depreciations and associated inflation increases. Laubscher touches on the movement of the Rand vis-à-vis the Volatility Index[12]. According to Laubscher, market volatility has increased enormously in recent times, coupled with extreme cases of risk aversion towards emerging markets. Globally, this translates into a withdrawal by investors from risky assets. This had a depreciating effect on the value of the Rand.

According to Table 1, household expenditure and gross fixed capital formation are expected to grow at significantly different rates. Specifically, household expenditure is expected to grow at only 1.6 per cent in 2009 and thereafter picking up to over 3 per cent in 2010. According to the 2008 Budget Review, household expenditure was estimated at 4.6 per cent. The 2008 MTPBS revised the 2008 household consumption percentage down to 2.8 per cent, partly as a consequence of higher interest rates, and the higher cost associated with food and electricity. In stark contrast to the growth in household consumption, gross fixed capital (formation) investment is expected to average about 9 per cent over the next MTEF.

South Africa’s economic policy challenges are in many ways similar to those of other emerging economies. However, South Africa has its own unique challenges which primarily stems from its past. These challenges relate to reducing poverty and unemployment. The MTBPS speaks to these challenges and mentions the following three policy challenges over the MTEF to drive higher economic growth:

Ø Increasing employment and enhancing competition;

Ø Raising investment; and

Ø Reducing external vulnerability.[13]

According to FEDUSA, the unfolding global economic climate highlights the need to address South Africa’s primary economic policy challenges, namely reducing unemployment and poverty, in a much more concerted way. In this way FEDUSA argued that this requires higher productivity. Furthermore, innovation and competition, along with investment in human capital, plant and equipment, and infrastructure is essential to sustain a long-term rise in productivity.

3. Fiscal policy

The fiscal stance presented in the 2008 Budget emphasised the financing of growth in government expenditure without placing an excessive burden on the economy or future generations. According to the National Treasury (2008b), the fiscal stance outlined in the 2008 MTBPS reaffirms government’s commitment to increase spending on infrastructure, public services and job creation, while making the necessary adjustments in a tougher global and domestic environment.[14] In other words, the fiscal stance as outlined in the 2008 MTBPS does not differ in emphasis from the fiscal stance outlined in the 2008 Budget – the only addition is that adjustments to fiscal allocations as stated in the 2008 MTBPS are inclusive of the tougher global and domestic environment.

The 2008 MTBPS makes provision for additional allocations totalling R170.8bn over the next three years – this implies additions of R170bn over the 2008 baseline. The main components of this amount include an allocation of R50bn (part of the R60bn loan[15] to Eskom announced in the 2008 Budget), and R59bn consisting of adjustments to spending programmes to accommodate higher inflation. The Expanded Public Works Programme (EPWP), the school feeding programme and municipal infrastructure also received significant allocations. The increased spending coupled with weaker revenue projections resulted in a forecasted budget deficit of 1.6 per cent of GDP for 2009/10.

According to FEDUSA, a fiscal balance of less than 2 per cent is acceptable, given the current challenges. In addition to the additional allocations listed above, the National Treasury through the budget framework also makes provision for a contingency reserve totalling R36bn over the next three years. Essentially, through the contingency reserve, the National Treasury makes provision for the fiscus to respond to unforeseen and unavoidable events.

In terms of debt management, the National Treasury pointed out that debt service costs have decreased from nearly 6 per cent of GDP in 1998/99 to 2.3 per cent in 2008/09. This decline in debt service costs was primarily attributed to declining budget deficits and fiscal surpluses in recent years. According to the National Treasury, the decline in debt service costs as a percentage of GDP was expected to continue over the MTEF, although at a slower rate.[16]

The Public Sector Borrowing Requirement (PSBR)[17] has increased mainly due to the significant increase in borrowings by state-owned enterprises to finance their capital programmes. Essentially, the PSBR refers to the amount by which government expenditure in a year exceeds government income. The 2008 MTBPS adjusted the PSBR upwards from R27.0bn to R30.4bn for the 2008/09 financial year and to R77.2bn for 2009/10. Specifically, as the National Treasury pointed out – the main factors driving the increase in the public sector borrowing requirement are the budget deficit and borrowing by non-financial public enterprises to finance their capital investments.[18] A significant portion of the short-term increase in the main budget borrowing requirement is to support Eskom.[19]

4. Tax policy

South Africa has in recent years experienced a significant increase in the Tax/GDP ratio. This was as a result of the widening of the tax base through legislative reforms, the reduction of loopholes, and the modernisation of the South African Revenue Services (SARS).

Table 2: National Budget Tax Revenue

R billion	2008/09		2009/10
	Feb. Budget	MTBPS	Feb. Budget	MTBPS
Total Tax Revenue	642.3	642.3	711.5	699.0
Income & profits	369.8	380.6	409.6	416.3
Payroll & workforce	7.5	7.9	8.2	8.4
Property	14.2	10.3	15.7	11.2
Goods & services	218.6	215.9	241.7	233.5
International trade	31.5	26.9	36.3	29.6

Source: National Treasury (2008b)

According to Table 2, tax revenue in the form of income and profits as per the 2008 National Budget is expected to be closer to the 2008 MTBPS. Much of this could be attributed to higher than inflation wage adjustments. According to BUSA, the underlying forces for this increase in the overall tax burden include sustainable factors such as the broadening of the tax base and better tax administration, and that they would like to see the overall tax burden stabilise over the medium term.

In terms of tax revenue for 2009/10 (i.e. estimates as per the 2008 National Budget and 2008 MTBPS), total tax revenue is budgeted to be lower. This could be partially attributed to a lower growth forecast and lower forecasted economic activity. Table 2 also reveals that for the 2008/09 financial year, tax revenues to be collected from property, goods and services, and international trade have been estimated downwards.

According to Table 3, main budgeted revenue for 2008/09 is expected to amount to R626.5bn or R1.2bn higher than the 2008 National Budget estimate in February. According to the National Treasury (2008c), the Tax/GDP ratio is to be revised down to 26.5 per cent, from 27.3 per cent as per the estimate at the time of the tabling of the National Budget in February 2008[20] (see Table 3). This slower growth will impact particularly on tax revenues from companies, Value Added Tax and customs duties.[21] In its presentation to the Committee following the tabling of the MTBPS, the National Treasury argued that the composition of tax revenues for 2008/09 will change – more will be collected from personal income taxes due to higher wage inflation and less from some indirect taxes, such as customs duties and transfer duties.

Table 3: Selected aspects of National budget revenue, 2008/09 – 2011/12

Source: National Treasury (2008b)

Roodt[22] made some comparisons of how different sources of revenue contributed to the fiscus in 1994 and 2008/09 (estimated). According to Roodt, company tax as a revenue sources’ contribution increase from 13 per cent in 1994 to 25 per cent in 2008/09, while individual taxes contribution increased marginally from 26 per cent in 1994 to 27 per cent in 2008/09. Roodt’s argument is that the higher corporate tax contribution in South Africa is crowding out potential corporate savings and that the solution in terms of revenue management regarding taxes should be along the following lines:

Ø Decrease company and personal income taxes;

o The burden on both companies and individuals has increased significantly;

o Higher taxes have discouraged savings;

o In terms of international comparisons, South Africa’s taxes are higher; and

o In terms of international comparisons, South Africa has less tax payers.

Ø Increase Value Added Tax (VAT) as South Africa’s VAT rate is lower by international comparison; and

Ø Do not zero rate more foodstuffs.

The following are some of the key tax/revenue reforms which accompanied the tabling of the MTBPS:

Ø Converting STC into a dividend tax at shareholder level by the end of 2009 or early 2010;

Ø Significant tax incentives to support:

o Industrial development;

o Construction of low cost housing by employers and landlords;

o Indirect equity investments in small and medium size businesses and junior mining exploration companies; and

o Newly constructed and renovated buildings in Urban Development Zones.

Ø Simplification of taxation of lump sum withdrawals (pre-retirement) from retirement funds as from 1 March 2009; and

Ø Tax compliance burden of micro businesses.

In response to these tax reforms, BUSA stated that it would like to see a period of consolidation to counter the complexity that goes hand in hand with new forms of taxation.

5. Conclusion

The MTBPS was tabled in the midst of what the Minister referred to as a “financial storm”. The MTBPS revealed the fiscal direction government wishes to pursue for the next MTEF. In the South African context, budgets and budget policy statements face two fundamental challenges – those that arise out of the current economic context, i.e. addressing poverty and unemployment; and those that relate to fiscal issues, i.e. fiscal policy must contribute towards realising these economic objectives, but in an ongoing and sustainable way.

The 2008 MTBPS addresses both these challenges through making available additional allocations of R170.8bn over the next MTEF. On the revenue side, slower growth and the global economic slowdown is likely to put a damper on tax revenue generated through indirect taxes. The resultant effect of additional allocations and the damper on tax revenues is that government has budgeted for a budget deficit – this in turn is set to raise the PSBR.

The following three fundamental issues stood out in the 2008 MTBPS:

Ø The increase in the current account deficit (the risk averse nature of global investors will have dire consequences for South Africa in financing its current deficit; essentially, the magnitude of the current account deficit potentially exposes South Africa to the risk of a financial crisis associated with a sudden stop of capital inflows);

Ø Slower GDP growth; and

Ø Inflation (Positive gains are on the horizon with the introduction of a new measurement and weighting system for inflation.

6. Recommendations

The Committee having considered the 2008 MTBPS makes the following recommendations:

6.1 The period for Parliamentary engagement with the MTBPS should be increased to allow for a comprehensive review and interaction with relevant stakeholders; and

6.2 National Treasury should show a heightened awareness for international economic events – essentially, such awareness would guide National Treasury in taking action if the need arises.

7. Oral Submissions

The following people made oral submissions before the Committee, some in their personal capacity. These submissions are available on request from the Committee Section of Parliament.

Mr T Manuel, Minister of Finance

Mr L Kganyago, Director-General: National Treasury

Mr. K. Naidoo, Deputy Director General (Budget Office): National Treasury

Mr J Laubscher, Group Economist: Sanlam

Mr. G. Ballim, Group Economist at Standard Bank

Mr. D. Roodt, Executive Chairman and Chief Economist at the Efficient Group

Ms. G. Humphries, Deputy General Secretary of FEDUSA

Adv. A. Meiring (BUSA)

Ms. S. Siwisa (BUSA)

8. References

National Treasury. (2008a). Budget Review. Pretoria: Government Printers.

National Treasury. (2008b). Medium Term Budget Policy Statement. Pretoria:

Government Printers.

National Treasury. (2008c). Presentation by the National Treasury to the Portfolio

Committee on Finance, 21 October 2008.

Report to be considered.

[1] Jacques Laubscher is the Group economist at SANLAM. He was part of the panel of economists during the MTBPS hearings.

[3] Goolam Ballim is the Group economist at Standard bank. He was part of the panel of economists during the MTBPS hearings.

[4] The Federation of Unions of South Africa (FEDUSA) also participated in the MTBPS hearings.

[7] Business Unity South Africa (BUSA) also participated in the MTBPS hearings.

[10] A measurement of the price increases of a basket of consumer goods and services. From 2009, this replaces CPIX as the main measure of inflation.

[11] The difference between total exports and total imports, also taking into account service payments and receipts, interest, dividends and transfers. The current account can be in deficit or surplus.

[12] An indicator that helps to determine when there is too much optimism or fear in the market.

[15] The Minister of Finance pledged R60bn of support over 5 years to Eskom in the 2008 Budget Speech. The R60bn will be disbursed over 3 years and will be in the form of a subordinated loan.

[17] The consolidated cash borrowing requirement of general government and non-financial public enterprises.

[22] Dawie Roodt is the Executive Chairman and Chief Economist at the Efficient Group. He was part of the panel of economists during the MTBPS hearings.