Deficit undershoot

In the Medium-Term Budget Policy Statement (MTBPS), the government upped its forecast for the 2009/10 deficit to 7.6% of gross domestic product from the 3.9% forecast in February this year. We continue to expect that the final outcome will be a budget deficit of 8.3% of GDP, writes Annabel Bishop, group economist of Investec Bank.

This record outcome will be due to the sharp fall in revenue and the government already estimates revenue will be R82.9 billion lower than the R740.4bn budgeted in February – we expect a greater drop in the final outcome.

In particular, taxes on companies’ profits (estimated R22bn lower than the R160bn initially budgeted for) and VAT (estimated R30.8bn lower than the budgeted R168.8bn) is driving this fall as the impact of the global recession bites home.

After expecting GDP growth of 1.4% for 2009, the government has revised this to a contraction of 1.6% of GDP, in line with our view. This has also contributed to blowing up the deficit, as a percentage of GDP.

In rands, the budget deficit moves from R95.6bn to R183.8bn – we expect R202bn as a final outcome. As expenditure is expected to exceed revenue by R183.8bn, consolidated expenditure is estimated at R841.4bn, 17.6% higher year on year, with an additional R12bn for the rising wage bill (R0.6bn for the creation of new departments) and R2bn increased spend on social services in an effort to improve service delivery. The non-interest expenditure is 76.7% of the total.

The Public Sector Borrowing Requirement (PSBR) is estimated at 11.8% of GDP for 2009 (budgeted 8%, we were expecting 12.6%, but there is scope for this figure to rise). Debt levels rise from 22.6% of GDP in 2009 to 41.1% by 2012, with the government funding most of its deficit in the domestic capital market. This will further crowd out the private sector and push up yields, eventually quite substantially, due to oversupply in 2010/11 when the budget deficit remains sizeable; we expect R199bn or 7.5% of GDP, the government currently estimates 6.2% GDP. The risk of a rating outlook or even revision increases as the government uses borrowings to fund current expenditure.

The impact on inflation, if the proposed electricity tariff increases are implemented, will be severe and ongoing, preventing the consistent attainment of the inflation target and casting doubt over the validity of the entire inflation targeting process. We maintain that the band should be widened to 1.5% or 2% around the midpoint, instead of the current 1.5%, with the midpoint itself at 5 or 5.5%.

While it was not expected that taxes would be increased now, as the economy reaches its lowest point, there is still a likelihood. This will most probably occur indirectly through the implementation of the National Health Insurance, along with higher electricity tariffs (200% mooted over three years), which will retard the recovery in consumer spending and hence job creation.

The loosening in exchange controls has caused the rand to weaken, which makes it a doubly positive outcome, as rand strength will retard economic recovery.
We believe the economy will expand by 1.6% next year after contracting by 2.4% this year, with no further interest rate cuts likely.

South Africa is not the only country seeing a drastic slowdown in government revenue collections while spending is rising. Budget deficits are rising globally as governments assist ailing companies to limit systemic crises. Policies (monies) need to aim outwards to increase job creation, particularly for the medium to longer term or, more specifically now, rescue ailing companies (and jobs) so that they can take advantage of the eventual upswing (by having remained in existence) to ultimately increase employment levels.
With the economic recovery expected to be slow and patchy, revenue collections will be below historic levels in the next fiscal year (2010/11) as well. The government will keep spending counter cyclical to ensure service delivery priorities are not negatively affected by lower revenue growth, thereby ensuring a fiscal deficit for 2010/11 as well; we expect -7.5% of GDP.

The government’s low ratio of debt to GDP seemingly makes it appear as though it can afford to have a higher budget deficit. However, interest on debt issued will need to be serviced by the dwindling taxpayer base and the increase in debt will also fund current expenditure. This could also likely result in an outlook or actual rating downgrades.