South African budget – reeling out the spare wheel?
This post is a guest contribution by Michael Kafe and Andrea Masia of Morgan Stanley.
If you were driving along the interstate, and had a flat tyre, you would generally be faced with two options: Reel out the spare wheel or preserve the spare for ‘later’ and risk being stranded. It is no different with fiscal accounting: If one made provision for unforeseen contingencies (e.g., unanticipated spending requirements, revenue shortfalls, a dry up in funding, etc.) and one or more of these contingencies unfolded over the course of the fiscal year, it would not be out of place to draw down on such reserves to plug the hole. In this case, the National Treasury of South Africa chose to make use of its contingency provisioning for this fiscal year, thereby allowing it to report a slightly smaller-than-expected deficit.
The Macro Backdrop
The Treasury’s macro assumptions have been downgraded across most categories, driven in the main by a weakening external environment, deteriorating levels of confidence, and volatility in global asset markets. GDP growth is now seen at 3.1% in 2011 and 3.4% in 2012, compared to earlier estimates of 3.4% and 4.1%, respectively (Morgan Stanley forecasts 3% GDP growth for both years). Household consumption has been revised lower, while fixed investment has been downgraded by close to a percentage point in each year across the forecast horizon. A weaker demand environment has done little to rein in the Treasury’s inflation forecasts, however. Indeed, domestic inflation, expected to be driven almost exclusively by cost-push factors, is now forecast at 5.4% in 2012 and 5.6% in 2013, from 5.2% and 5.5%, respectively. Finally, the current account deficit is expected to shrink in line with the more somber growth backdrop.
Contingency Reserves to Fund Spending Increase
Details of the October 2011 Medium-Term Budget Policy Statement (MTBPS) show an increase in recurrent expenditures from R588 billion in February to R592 billion – exactly as we had expected. Transfers and subsidy allocations of R313 billion were in line with our R315 billion estimate, while capital assets and other expenditures also came out in line with the R75 billion print that we had expected. Interestingly, however, the headline expenditure reading remained unchanged at R979 billion – much lower than our forecast of R987 billion, thanks largely to a drawdown on the contingency line (R4 billion) as well as a modest undershoot in the wage bill (R4 billion). We must point out that, although basic wage negotiations in the public service were concluded in 3Q11, outstanding issues surrounding housing allowances are yet to be resolved. On our estimates, this could lead to a further R2-3 billion increase in the wage bill once settlement is reached. We are therefore happy to stick with our wage bill estimate of R347 billion for fiscal 2011/12, which is slightly higher than the Treasury’s R343 billion estimate.
Over the medium term (2012-14), the government hopes to spend some R802 billion on infrastructure – slightly lower than the R808.6 billion that it planned to spend over 2011-13 as per the February 2011 Budget. Of this, the estimated outlays on economic services infrastructure such as water & sanitation, transport & logistics and energy have been raised from R664 billion to R676 billion, while supportive infrastructure on social services such as health and community facilities has been scaled back while spending capacity is being built in these latter sectors.
Looking forward, although the Treasury’s wage bill for the upcoming two fiscal years is likely to push the recurrent/capital ratio in the ‘wrong’ direction, it is important to note that this is already priced into our forecast. Increases in transfers, subsidies, capital assets and other expenditures are also as we had expected. The headline expenditure reading, however, is slightly lower than we expected – again simply because the Treasury has decided to halve its contingency provisioning for the outer years to help plug the burgeoning revenue gap.
Revenue Undershoot in Line with Expectations
With regards to fiscal revenues, Treasury estimates of R814 billion are in line with our R815 billion estimate, although details on the various tax handles as well as between tax and non-tax revenue do show some variation. The greatest variation is expected in VAT receipts, which the Treasury expects to come in at a rather conservative R187 billion (our estimate R195 billion), thanks to higher-than-anticipated VAT refunds. Revisions to corporate and personal tax estimates were in line with ours.
Fiscal Deficit Lower than Expected
As expected, the fiscal deficit was also revised upwards, thanks to higher spending and lower revenues. The Treasury’s estimate of 5.5% of GDP for this year is however marginally lower than our 5.8% estimate, thanks mostly to the drawdown in contingency reserves.
Excess Cash Holdings to Fund Borrowing Requirement
With regards to funding, the MTBPS presents an unchanged debt position, as it hopes to fund the higher deficit from two key sources: i) a drawdown on its cash holdings in the National Revenue Fund; and ii) embarking on a switching program that will allow it to swap maturing debt for longer paper, allowing for better cash flow management.
With regard to the drawdown in cash, it appears that most of this will be a part-liquidation of its effectively dormant foreign exchange deposits at the SARB – again, another prudent decision to fall back on idle reserves in difficult times.
This not only allows the Treasury to minimize net interest payments, but also ensures that its debt ratios are kept in check – an important metric that rating agencies have focused on lately. And while there may be some liquidity and/or FX implications as the cash holdings are withdrawn, we believe that such an impact will be virtually negligible.
On the whole, the Budget is reflective of a rather innovative Treasury team that has been able to adeptly maintain its expenditure targets in the face of a shrinking resource envelope without compromising the country’s debt ratios. Faced with lower revenues and a slightly higher baseline expenditure bill, the Treasury appears to have made good use of the cash buffer that it has built over the years. From a macro perspective, we believe that this was the prudent thing to do in such difficult times.
Source: Michael Kafe and Andrea Masia, Morgan Stanley, October 28, 2011.