SA Budget 2008/9

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By Alwyn van der Merwe

In the good old days economists used to work through the night to get their reports out following the budget. The reason was not only work ethics but the fact that previously the budget was full of surprises as the process was certainly not an inclusive and open one. Under Trevor Manual everything changed as the budget was a process rather than a once-off event to keep economists busy and guessing in terms of the outcome. The “process” kept surprises to a minimum and to some extend this very important policy tool became less of an event. Of course, the very consistent approach or recipe of the Minister helped enormously.

This year, however, a few commentators were holding their breath following the obvious swing to the left within the ANC. The big philosophical issue was really whether the minister would be in a position to demonstrate his independence by sticking to his tried and tested approach. The “believers” were rewarded as the minister did not deviate from his core fiscal themes which became synonymous with his tenure.

The intention of this note is not to repeat what the Minister said. I would simply like to highlight a few of the salient points from an economic perspective and the potential impact on financial markets. In these notes I have also borrowed from the views of the SIM economist, Arthur Kamp.

I mentioned that the Minister was consistent with fiscal policy previously employed. Fiscal discipline featured strongly. The following defining features illustrate it:

The consolidated national budget continues to project surpluses over the next 3 years.

• The total government net loan debt ratio falls to 15.9% by 2010/11 from 22.3% at end 2007/08.

• State debt cost declines from 2.6% of GDP in 2007/08 to 1.9% in 2010/11.

• Government’s contribution to national savings increases to 1.5% of GDP by 2010/11 from 0.8% in 2006/07.

• The total public sector borrowing requirement, including borrowing by non-financial public sector enterprises such as Eskom, rises to 1.2% of GDP (R27bn) in 2008/09 and 1.4% in each of the following two years, from -0.1% of GDP in 2007/08, which is still low.

• Exchange control liberalization1 continues to the point where the shift from exchange controls to prudential regulation changes the focal point from pre-approval of applications to monitoring of cross-border flows.

• The corporate tax rate has been cut by 1% to 28% and R5bn in tax subsidies is provided over the next 3 years for labour intensive industries, while red tape is reduced for small business enterprises.

One of the big topics under discussion prior to the budget speech was how the current problems within Eskom and the parastatal’s inability to provide power to the growing needs of the economy will be addressed in the Budget. The Budget addressed the Eskom financing issue with government providing R60bn over the next 5 years for Eskom’s investment programme in the form of a loan (including an anticipated draw-down of R20bn over the next 3 years, which is provided for in the contingency reserve). In addition, R2bn is set aside for support programmes aimed at encouraging more efficient use of electricity and generation from renewable resources.

Also, over and above the introduction of the electricity levy, the Treasury indicates the need for tariff adjustment to reflect the true cost of producing the electricity. The latter is a key point. Tariff adjustment certainly has the potential to contribute strongly to more efficient use of electricity as seen, for example, in the case of Brazil earlier this decade. My view is that this tariff increase will only be the first one and we should expect more of the same in the future.

If one needs to be critical, one can criticise the Minister for the in terms of the timing of the further relaxation of exchange controls in this budget. I have long held the view that they have missed the opportunity to relax exchange controls from a position of strength. They undoubtedly missed the opportunity in the previous two budgets when the currency was firm and foreign investors fell in love with SA. The full potential impact of the relaxation is an estimated outflow of pproximately R130bn. Given the perfect storm that has hit the currency, one can certainly question the timing of this announcement.

Thus it was no surprise to see that this announcement invoked the usual sell-off of the rand. I know that some commentators argue that the fiscal policy framework tabled by the Minister yesterday ensures fiscal sustainability, promotes the continued integration of South Africa into the global economy and continues to complement the Reserve Bank’s crusade against inflation. From a “fundamental” perspective this Budget is no reason to sell the rand.

Naturally if there were only a few surprises in the budget then it should not cause financial markets to pull sharply in a particular direction. Overall it should provide some confidence to investors. One of the areas where we have received confirmation of government’s commitment is in the area of spending on infrastructure. Infrastructure spending gets an additional boost with expenditure over the next three years now expected to amount to a cumulative R568bn, compared with the previous estimate of R482bn. The difference primarily reflects additional spending by Eskom. Over the next 3 years an additional R207.4bn is budgeted for electricity supply expansion, followed by a further R135.5bn in the following two fiscal years.

Total public sector infrastructure spending is forecast to amount to 6.9% of GDP and 7.9% of GDP in 2008/09 and 2009/10 respectively. From a top-down perspective it supports our view that there is still something left in shares like Murray and Roberts and Aveng and the like.

Potential weakness in the currency might well provide a boost to rand-hedge shares. Although that might be true in the short term, my view is that the longer term implication for the currency should rather be positive than negative.

In summary, the Minister’s consistent approach continues to deliver favourable results, which is the reward for many years of fiscal discipline, improved efficiency in tax administration and innovative thinking. Any takers for his position?

Source: Alwyn van der Merwe, Sanlam Private Investments, February 21, 2008.

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