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FNB Comment: Reconciling spending, frugality and growth

27 Feb.

FNB Comment: Reconciling spending, frugality and growth.

It is a challenge, but it can be done, attempting to achieve three mutual exclusive objectives simultaneously.

It turns out to be a combination of remaining generous on social spending intentions, though intending to be somewhat more severe on real public wage gains, and sacrificing some short-term growth through tax increases and other inbuilt restraints, thereby gaining greater budget frugality and market buy-in while focusing on long-term investment-led growth when global crises may be less intense, public sector skill constraints hopefully less pressing, public borrowing ability somewhat easier and ideological reservations about greater private participation less of an issue.

Our Minister of Finance did all of this in the past week, in ways that his Greek and German counterparts would have understood only too well.

In common with so many other stressed countries today, South Africa has two diametrically opposed constituencies in the form of her electorate and financial markets.

The main demand from our electoral majority is for redistributive spending to address the ills from the past, either in genuine attempts at solutions or simply as compensation for the many inherited iniquities.

The Minister of Finance has the unenviable task of moderating these demands to within reason, relative to what the beast of burden (the economy and the relatively few taxpayers contributing the bulk of the country’s tax revenue) can seriously carry.

Or as a 17th century French Finance Minister put it, how to pluck the most feathers off a goose with the least hissing. There was evidence in Parliament on budget day that the Minister wasn’t quite succeeding on this score.

Be that as it may. As in every budget in recent years, there was again major emphasis on how much government spending would increase, for the first time comfortably cracking the R1 trillion barrier, causing the Minister to tell parliamentarians when they weren’t responsive enough that this was something to applaud him for (never mind inflation doing most of the heavy lifting, something to criticise him for instead).

Over three years, the social spending intentions runs in some instances in the hundreds of billions, with emphasis on satisfying the spending ministers and the watching television audience at home, in the macro assumptions still suggesting over 4% government consumption growth compared to 4.5% in recent years.

Yet while the Minister was trying very hard to maximise the appreciation impact of his spending intentions on his fellow Ministers and electoral majority, he was also doing a few other things.

These are risky times globally, with crises raging in Europe especially, a time to be cautious.

This was partly blamed for lowering the expected GDP growth rate for this year to a lowly 2.7%, with exports expected to be underperforming compared to both last year and next year.

This may well turn out to be the case, but more likely due to some kind of oil shock rather than the European crisis. Whatever its true nature eventually, it represents caution on the side of the Minister, which in uncertain times like the present is not misplaced.

The other main reason for low GDP growth expectation is slower expected household consumption growth, also a reflection of less external income support but perhaps more reflecting the many (unexpected) tax bites and higher inflation eroding real consumer income, slower public servant real income growth and slower real growth in transfer payments off a by now very high base.

Then again, such a low growth assumption assists in reinforcing the impression of the Minister having little means and being ever so reasonable (like last year) in demanding some abstinence from spending ministers while advocating a shift in focus away from (salaried) consumption to infrastructure capex.

Thus the Minister expressed the intention to after all keep real spending growth to 2.6% annually, a rather low number, given the macro assumptions and when allowing for how the year ahead may still unfold (wages especially).

Having made his pitch to spending ministers and electoral majority about being supportive for continued high social spending, he changed the emphasis towards austerity, also with his other major audience (markets) in mind.

It turned out all ministers had after all to do with less (projecting 8.8% nominal spending growth in a 6.1% inflation environment) but none more so than the bloated public wage bill, still absorbing over 40% of all public spending and now proposed to grow only by a nominal 7% annually for the next three years (reflecting 5% cost of living adjustment and the rest being notches meant for career progression), translating into 1% real increases.

Also, this limited wage bill space is presumably supposed to take care of public sector job growth, a rather challenging task in these politically trying times.

It is hardly certain that all these objectives will in fact be achieved. Even if spending Ministers keep themselves broadly to the spending limits, unions have reportedly already expressed disagreement with the idea of being limited to only 1% real, while surely government will still want to expand its staff complement by a few percentage points annually, when going by recent years and futuristic promises?

Be that as it may. It is something that will be argued about in time, and then settled, whatever it takes, bearing in mind the presence of a contingency reserve in the budget, a shock absorber for ‘unexpected’ overruns, and also when allowing that in recent years capex underspending has compensated for overspending elsewhere. As things stand, with those caveats, the printed budget looks coherent and contained.

There was good reason for the suggestion of overall spending frugality. For while the electoral majority can be reasonably satisfied that its education, health, housing, security and public administration is well looked after, at least in spending largesse if not always in final delivery, even if spending Ministers may be dissatisfied with the crumbs and public servants unhappy with the intended 1% real, it was necessary to dress the numbers this way with credit markets in mind.

Financial markets worldwide have of late only had one thing in mind, and that is to see budget deficits shrink as fast as possible, arresting public debt spirals and returning national finances to health in the shortest time feasible, serving the security interest of capital.

Not that our national finances ever got truly shot in the tribulations, for we were spared much in recent years (relative to what happened to some other countries).

Still, there was a recession, tax revenue fell away while public spending rose supportively, ballooning the deficit and causing the debt to start spiraling, and this had to be arrested pronto.

Which it was.

The Minister trimmed his total spending growth projections slightly lower while tweaking his revenue projections slightly higher off a higher achieved base, pleasingly improving the critical ratios.

Though this may have sacrificed growth in the short-term, the budget deficit, which only late last year was still expected to be 5.3% of GDP in 2011 came in at 4.8%, this year was projected at 4.6%, next year at 4% and by 2014 we should be back at 3%.

That’s excellent progress, even if the higher tax take and other assumptions (along with higher inflation) cause headwind to growth this year.

As a result gross national debt will probably peak at 42% of GDP and net debt at 38%, double its 2007 level, but at least contained at pleasingly low levels compared with many overseas countries in deep trouble.

This the financial markets found enormously pleasing, on the day rewarding the government by lowering its borrowing cost. Also, these fiscal estimates must have send a powerful message to the global rating agencies, which only recently had put us on watch (something that can lead to a credit down-grade if not addressed).

Overall, therefore, when going by media reports, the Minister succeeded in gaining the approval of both the electoral majority (which has reason to remain deeply grateful) and markets (which saw their language spoken).

But that left the third objective, namely growth. Though sacrificing growth somewhat short-term in the name of needed budget frugality, the longer term intention focuses on alleviating supply side constraints and achieving the means to more thoroughly address poverty and inequality, partly through more job growth.

And the engine of choice here, appropriately, is a very ambitious infrastructure wish list, already way behind schedule in energy, rail, ports, roads, municipalities, water and much else, but coming into focus anew.

Our GDP growth has been held back in recent times by severe infrastructure bottlenecks. Addressing these supply side constraints could lift the growth rate, initially through higher fixed investment and afterwards through more exporting and local output, thus assisting with creating more job opportunity in the economy.

Both electorate and markets could see the benefit of that for themselves, but how to present this?

The Minister opted for making known the entire wish list of future public investment projects being taken into account, amounting to some R3.2 trill, of which the next three years are intended to absorb R845bn.

Here is an ambitious infrastructure agenda that might just fly, seeing that so many are talking about it, including the President, various spending ministers and now in the greatest detail the Minister of Finance lifting the veil on the many needs and wishes as well.

Yet there was a humble acknowledgement of limited skills in the public sector to manage such a pipeline, and requiring many years of skill training to be overcome.

As it turned out, the Minister showed little evidence of such large additional investment ambitions imminently affecting his financing requirement or fixed investment and growth expectations.

His projected public sector borrowing requirement falls as share of GDP these next three years as the budget deficit comes off, even though there will be some increased borrowing by Eskom and Transnet.

Similarly, there is little in his macro assumptions about faster fixed investment growth, averaging only a modest 4.5% these next three years, as compared to averaging 14% annually in 2007 and 2008 at the peak of the last fixed investment boom.

Any infrastructure boom, if there is to be one, may only occur beyond 2014 for she is yet to be shown up in the projected GDP growth or the borrowing requirement.

Indeed, the Minister did mention that in later years (beyond 2014) the public sector borrowing requirement may again rise rapidly as public infrastructure investment accelerates.

This may actually have suited the immediate present, for the main priority in the short-term is to keep convincing markets of intended frugality as reflected in improving finances for this year and the years through 2014 to win their continued support in these trying times, keeping government long-term borrowing costs low.

Indeed, the Minister suggested that most such future borrowing will not come via the government’s balance sheet but via public corporations and other entities and may require private participation for which the means and appetite exist.

This suggested a bit of an ideological twist, backing the sentiments of the National Planning Commission’s Vision 2030, if perhaps not quite the spirit of the New Growth Path.

The suggestion of more private involvement reportedly already ran into some early polite demurring from involved Ministers and other public servants, preferring public corporations to retain say over such strategic projects rather than government losing its monopoly of being able to own and influence infrastructure.

So not now wanting to tax to find the substantial means needed, not wanting to overburden even as other social demands are just around the corner (such as the NHI for which an extra R6bn annually will be needed by 2014) and not knowing who would be doing the future borrowing, if any, it was easier for now to remain quiet.

Projects were listed and discussed in some detail in the background papers in support of President Zuma’s State of the Nation speech, but the sourcing of funds wasn’t clear while also not boosting fixed investment projections as part of the macro assumptions.

Expected GDP growth remains modest at 3%-4% through 2014, thereby being both a relative dampener for social spending ambitions and unions while providing incentive to do (much) more on the infrastructure investment front.

If such higher public fixed investment is going to materialise, it may do so only after 2014, when the present overseas crises may be less intense and risky for us, a beginning may have been made with training more skilled public sector manpower making things a lot more digestible and sustainable AND the government may by then have attained greater internal agreement as to private involvement (whose absence could limit ambitions but whose participation would be a great boost all round).

So, overall, the budget was a remarkable achievement, keeping the electoral majority reasonably happy regarding spending intensions, convincing frugal markets that discipline was being restored to our public finances faster than thought, and that in addition the nation in support of President Zuma’s vision will embark on a great infrastructure expansion, though perhaps not quite soon enough to warrant a showing in the investment and public borrowing estimates.

So we have ongoing redistributive social spending, if contained in places, such as welfare and wages (as expressed intentions).

Our public finances will be stabilised faster than imagined and thereby pleasing financial markets.

And we are nationally projecting an enormous infrastructure ambition which eventually should start colouring our growth performance, but probably more so in the second half of the 2010s rather than the first half.

And then there await the glorious 2020s, as per Vision 2030, even if still very distant today.

Lastly, to ensure that the books kept balancing, the ultimate objective of any Treasury, the Minister needed a few more resources.

We hear that personal income tax will be generating 14.5% growth in collections this coming year (after having absorbed R9.5bn of ‘relief’), abolition of the 10% STC (secondary tax on companies) was only partly compensated with the introduction of a personal 15% withholding tax on dividends (due to the many exclusions), the fuel levy was increased by R4.5bn, the electricity levy and capital gains taxes raised by R2bn apiece, and this all in the name of equity, a thin veneer for simply needing to balance four irreconcilables (social spending, financial frugality, tax reform and investment-led growth).

Along with higher inflation, such tax bites corrode real consumer income and reduce ability to sustain consumption spending, the extent of which may become clearer as the year unfolds, constituting a short-term growth sacrifice in the name of pressing national priorities.

At the same time, the Minister suggested that corporate tax collections will be only 9.7% higher this year, which makes sense relative to a 10% nominal GDP growth number, but seems understated relative to the cyclical recovery in business earnings currently underway. If understated, it provides a nice contingency buffer for the Minister in the coming year, as at times in the past.

Finally, the Gauteng tolling issue was taken to a new level with a once-off injection into Sanral of R5.8bn (borrowed?), with lower discounted toll rates offered to sugarcoat the bitter pill of yet more taxation.

But whether this gesture will do it, only the unfolding year will tell, as with so much else.

Overall, this was a budget whose success must be measured by its general acclaim, communication-wise succeeding in nearly every dimension as discussed here, except for the disgruntled decrying the unexpected wealth tax increases being meted out to them, causing the Minister in a momentary flare up of social passion to contrast the far worse possibility of 100% (“like elsewhere”) rather than “only” our 15% (dividends) and 33.3% and 66.6% (individual and corporate capital gains).

It makes one wonder, though, what is still to come in future years as public needs keep expanding.

Cees Bruggemans, Chief Economist, FNB

Cees@fnb.co.za
Twitter sound bites @ ceesbruggemans

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About Coastal Roy

A consultant experienced in the financial sector in Africa and with a background of central banking, the financial system and information technology. Area of expertise: - Financial market development and regulation. - Payment, clearing and settlement systems modernisation and regulation. - Strategy and policy development for central banks and the financial sector. - Capacity building, advising and mentoring in financial sector development. Educational qualifications: - Master of Business Leadership, degree; UNISA - BSc (Hons) degree in Physics, Manchester University

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