REPORT ON THE MEDIUM TERM BUDGET POLICY STATEMENT 2003
The Portfolio Committee on Finance reports as follows:
The Minister of Finance tabled the Medium Term Budget Policy before Parliament on 12 November 2003. In joint sittings together with this Committee, the joint Budget Committee and the Select Committee on Finance were briefed on the Medium Term Budget Policy Statement by the acting Director General of Treasury, with the Minister of Finance and the Commissioner of the South African Revenue Services present. Submissions by selected economists on macroeconomic, fiscal and tax issues were also heard.
As the Minister pointed out in his speech, the 2003 MTBPS draws on the government’s 10-year review and the Growth and Development Summit, which focused on priorities for improving growth and broadening participation in the economy. Essentially, he reported that the essential elements of a stable a stable, growth oriented fiscal framework, with strong emphasis on sustainability, are in place. These enable an expansionary fiscal stance, with strongly increasing social spending.
Other themes of the MTBPS are:
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The continued global economic slowdown and strong rand made it necessary for Treasury to adjust estimated growth down from 3,3% to 2,2%. However, it is expected to increase to 4% by 2006. Thus positive domestic growth continues, though more slowly, as weak international demand affected manufacturing exports, which are also impacted to a lesser extent by the strong rand.
Global recovery, though emerging more slowly than Treasury anticipated in February, is getting under way, mainly in the US and East Asia. It is expected to support SA economic expansion in the medium term, and growth oriented fiscal policy proceeds on course. Commodity prices are rising, as international recovery begins to strengthen, but the strong rand again blunts positive effects of this on the domestic economy. Higher oil prices are also a negative element. However, world GDP is expected to rise from 2% in 2003 to 3% in 2004, given considerable fiscal and monetary stimulus by the US, while a weaker dollar will support US demand. Sustained recovery may however be constrained by the US’s "huge twin deficits" - both fiscal and balance of payments.
The rand is now back to its levels of 2000. The period of rand weakness from late 2001 proved inflationary, offsetting its boost to exports. As a strong but volatile currency, the rand is in a similar position to other resource economies in a weak US dollar context.
Trade performance in SA has seen geographical and product diversification, and a number of bilateral and multilateral trade agreements concluded. Some 19% of SA exports are now duty free under AGOA, though again such trade has been dampened by the rise in the rand. Manufactures now dominate exports to the US, though the EU remains SA’s major trade partner. The SA-EU trade agreement provides a framework for further expansion.
The balance of payments is expected to record a deficit of about 1% of GDP this year, following a surplus in 2002. The weakening of the trade surplus is matched by a continuing deficit on the income and service account. The combination of real effective rand appreciation and the global slowdown reduced export earnings in the first half of 2003. Falling interest rates and fiscal stimuli meanwhile supported domestic spending, including a strong growth in investment, This contributed to an increase in import expenditure of up to 2% over the first half of 2003.
Weaker tourist spending and weaker dividend inflows increased the services and income account deficit, and the surplus on the financial account, reflecting net portfolio inflows, proved insufficient to finance the current account deficit. However, growth in capital good imports indicates rising business confidence, and a base from which to meet rising global demand.
SA’s foreign reserves increased: by end September 2003 gross gold and other foreign reserves had risen to US$20,2 billion, up almost 30% from march 2003. The net open forward position of January 3003 was US$1,5 billion, which was completely eliminated in May 2003. Subsequent reduction of foreign exchange contracts has contributed to the NOFT strengthening to a positive US$1,8 billion at end September 2003. This was also a factor in the strengthening of the rand.
Real output growth is down to 2%in the first half of 2003, for reasons set out above. Against this background, SA firms have continued strong investment in production, with investment expenditure growing at 8% in the first half of 2003. Fiscal initiatives in manufacturing should also have a positive effect. It is also expected that government infrastructure growth will support construction in the medium term.
In the primary sector, agriculture is contracting due to drought; while high gold and platinum dollar prices somewhat offset the negative impact of rand strength, though marginal mines are under threat. Strong global demand is expected to drive growth and future investments. Tourism is SA is increasing, and increasing capacity, against the backdrop of a world decline.
Gross domestic expenditure is growing more rapidly than GDP. Household consumption has slowed, but remains robust. With falling interest rates, increased consumption, and strongly increased investment is expected.
Interest rates saw 2002’s 4 percentage point increases countered by 5 percentage points cuts in 2003. Inflationary pressures had abated partly because of the rand’s rise. The rate cuts will support increased consumption, investment and overall growth recover,
Technical adjustments to the CPIX inflation targeting framework set the 3-6% range as a continuous month on month target rather than an annual average. The 3-6% range will remain the target until beyond 2006. The inflation rate is expected to remain within the band over the forecast period. The ‘escape clause’ for the SARC to use in the case of shocks has been amended to an ‘explanation' clause, whereby the SARC informs the public of any shocks and impact on inflation.
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Government’s aim is a stable, growth oriented fiscal framework, with strong emphasis on long-term sustainability. Despite world conditions and export slowdowns, the expansionary stance begun in the 2001 budget continues. Real growth in non-interest spending of 5,7% in 2004/05 is projected, with an average of 4,4% per year over the MTEF period.
The revenue shortfall is expected to be some R4,6 billion, due to the slowdown. The budget deficit accordingly increases to 3,2% of GDP in 2004/05, declining to 2,8% in the outer framework year.
Consolidated national government deficit remains below 3% of GDP – in a context where EU members are struggling bring their deficits to this level – throughout the period. Though exports are expected to fall, pulled down by a strong currency and a weak international economy, firm domestic consumption and investment growth will boost import demand.
Growth supporting mechanisms are
Key MTEF trends are:
Thus fiscal policy is enabled to remain expansionary, with rising spending on social benefits as well as infrastructure and empowerment. The division of revenue increases transfers to provincial and local government for delivery of free basic services, health, education and infrastructure.
Policy measures announced in the 2003 Budget and subsequently given effect in the Revenue laws Amendment Act include incentives for urban renewal, reduction in the tax on retirement funds, allowances to encourage business investment, and adjustments to foreign business taxation. The Commissioner of Revenue added that working toward a decision on retirement funds is a work in progress, currently involving active consultation.
Provisions to facilitate and extend the foreign exchange amnesty to end February are under way. The Minister indicated that some 5800 amnesty applications have been received, with dramatic speedup in October. There is a high acceptance rate of applications. The amnesty unit is overloaded, and has had to increase staff.
The revised forecast for 2003/04 expects main revenue at R299,9 billion, R4,6 billion less than budgeted, mainly due to lower export growth and reduction of company profits and customs on imports. The Minister emphasized that with the shift in revenue composition towards increased corporate
Revenue outcome and projections indicate that main budget revenue will be R278,2 billion, which is R13,2 billion higher than budgeted, due to higher than projected increases in remuneration, GOS of companies, expenditure growth and inflation.
Tax policy for the 2004 Budget will
In additional provisions, there will be tax breaks for inner city developments, no tax on foreign dividends, and provision made for the plastic bag levy . The tax on derivatives will be reviewed. Personal tax cuts are unlikely in 2004
Key spending priorities for the 2004 Budget are:
Social services have attracted the largest spending increase, with social security increasing by 12,7% a year. The first phases of setting up a national Social Security Agency will be funded through the Department of Social Development.
There is an undertaking to restructure the unemployment insurance fund, and to provide for significant modernisation of the Justice system. A move to improve the quality of key economic data is envisaged, and some R750million is provided to recapitalise the Post Office.
Division of Revenue between spheres of government provides for additional allocations of R37 billion over the MTEF period. . apart from an adjustment for higher salary costs, and R6 billion for Bee initiatives, R29,2 billion goes to the three spheres for enhances services and new priorities. National departments receive 23%, Provinces 64%, and local government 13% - relatively the largest increase.
DIVISION OF TOTAL RESOURCES
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Increased resources directed to the three spheres indicates policy commitment to strengthening key provincial and local government programmes which are essential to progressive attainment of basic social and economic rights and improvement of living conditions.
Additional funding allocated to the provincial sphere aims at:
Growth in transfers to local government targets the rollout of free basic services: the accelerated rollout of free basic electricity, water, refuse removal and sanitation to poor households; and strengthening municipal infrastructure delivery. Key capacity is involved in the process of consolidating local government financial management and budget reforms as envisaged in the municipal finance Management Bill.
Additions to the infrastructure grants of the provincial and local spheres have an essential role in successful delivery of pro-poor services.
SECTION 2. ECONOMISTS’ VIEWS ON THE MTBPS
The Portfolio Committee on Finance, the Select Committee on Finance, and the Joint Budget Committee together heard views of three economists on the MTBPS. These were Prof Ben Smit of the Stellenbosch Bureau for Economic Research, Mr Mandla Maleka of BUSA , and Mr Dennis Dykes of Nedcor.
The three economists concurred on a number of fundamental points:
2.1 Prof Ben Smit
Prof Smit stressed SA’s remarkable macroeconomic stability since 1994. The growth rate since then, while not as high the wished-for 6%, has been far less volatile than in the past, remaining positive despite shocks like the 1998 Asian crisis. The balance of payments as a percentage of GDP has also become less volatile. And the inflation rate appears to be moving from a norm of around 14-10% to 8-5%.
SA currently has a strong and volatile exchange rate. The real trade-weighted rand is back to the levels of pre-Asian crisis 1998. Other commodity exporting countries such as Australia and Canada also show very strong currency appreciation in 2003. Improved fundamentals and a dollar slide brought investors who sought good interest return with limited prospects of a sudden drop. At present cutting interest rates would not be the answer to getting the rand to fall, since it would merely attract such investors into short-term funds.
The net open forward position (NOFP) is now positive, with government now working in the short term to get rid of the forward book. With that achieved, building up foreign reserves can get under way. This will ultimately take the pressure off the rand.
The limited slowdown in 2003 shows an uptick in recent months, driven by the motor and construction industries, though other manufacturing, particularly AGOA beneficiaries, and marginal mines, are suffering from the strong rand.
SA’s fiscal policy intentions are explicit and have been consistently maintained, conferring predictability, a key element of stability. A number of fiscal variables were reviewed, among them government savings, which indicates that government has stopped being a net drain on the nation’s savings pool. The strongly declining trend of the deficit before borrowing started before GEAR was formally adopted, and has gained government sufficient credibility that a temporary shift over the 3% deficit level makes little impact.
Similarly, the steady MTBPS ratios of tax to GDP, debts service costs that continue to drop despite the present economic dip, government debt that remains under 40%.
Three key areas of government development policy still await solutions. First, education and training is so far not convincingly beating the skills deficit – apartheid’s cruelest legacy. Next, financing of SMMEs has not yet proved soc successful. Finally, little is said about restructuring in the MTBPS; it may prove a missed opportunity.
2.2 Mr Mandla Maleka
Mr Maleka welcomed the announcement of largest spending increases in the social sector in the context of growing unemployment and HIV/AIDS. The slight projected increase in the deficit for next year is tolerable in the knowledge that there is no shift away from commitment to low deficit ratios.
The allocations for HIV.AIDS and for the EPWP are welcomed, the latter as a way of bringing the marginalized into the formal sector, however briefly. The public works programme should have a bias to rural areas, to counteract the magnet effect of increasing social services available in urban areas.
He welcomed allocations for BEE, pointing out that while in general the market must determine prices in the economy, extensive intervention is needed to counteract the distortions left by generations of exclusion.
Mr Maleka called for further stimulatory tax cuts in the budget, and special tax relief for small concerns.
2.3 Mr Dennis Dykes of Nedcor
Mr Dykes discussed trends in the global economy in some detail, noting that cyclical momentum is picking up, with a policy-induced upswing in the US. China is growing strongly, which has implications for SA’s resource sectors,. Elsewhere growth remains slack.
Fiscal deficits are running high in the US and a number of European economies. In the US, high corporate and individual debt and the growing budget deficit are ominous structural signs that a recovery may not last. Europe and Japan currently are currently static.
Discussing the implications of the 65% increase in the rand in the past year, Mr Dykes stressed the extent to which its appreciation was a reaction to dollar weakness. However, the rand is still 5-18% below its estimated purchasing price parity. Assuming an unchanged trade-weighted basket of currencies, a relatively unchanged euro-dollar exchange rate of between 1,17 and $1,30 and an appreciation of the rand, the rand should trade at between R5,90 and R6,30 to the dollar. On a depreciating currency, the rand could trade between R7,35 and R7,80. The former option is highly adverse for the export sector.
The SA economy over the past decade shows a rising trend in spending, but not in production. At present spending is rising, with consumer spending strong. A further interest rate cut is possible, and rates should remain low next year, barring shocks, but will then begin to climb again.
Overall, fiscal policy has created space and credibility for strong stimulus: ‘It is appropriate that the fruits of fiscal discipline should now be enjoyed."
Mr Dykes also called for tax support for small firms at risk in the weak export market. He also found restructuring of state assets underemphasized in the MTBPS, and argued for introduction of competition into public sector markets which need efficiency and to attract foreign technology.
The Committees focused concern on the effects of the strong rand, and were told that sectors suffering included textile exporters, many of the AGOA exporters, some automotive producers.
The economists were asked whether expenditure on public works was the most effective way to stimulate poorer sectors of the economy, as opposed to for example SMME support or land redistribution. It was agreed that SMMEs did not receive vigorous support, while the EPWP, with their short time spans, are essentially poverty relief.
The combination of targeted pending into infrastructure and capital goods, running alongside major education and training efforts was cited as the combination required for sustained growth.
The committee once again wishes to express its concern about the lack of progress in the reform of the budget process in parliament and the diminished oversight role accorded to parliament in this regard.