Budget 2010: Finance Minister Reaffirms Policy Cornerstones in South Africa

In his first budget speech, on 17 February 2010, Finance Minister Pravin Gordhan reaffirmed the policy cornerstones of South Africa. Working with a recession-induced revenue shortfall, he committed to prioritise spending on infrastructure and employment creation, while keeping the fiscal shortfall in check

Economic Projections Revised

The Treasury revised the GDP estimates upward for the next three years. GDP growth is now more in line with IHS Global Insight's expectations for 2010. The Treasury now expects 2.3% year-in-year (y/y) growth in 2010 (IHS Global Insight's expectation: 2.5%), up from the 1.5% spelled out during the medium-term expenditure framework in October 2009 (see South Africa: 28 October 2009: South African Government Debt to Double over Next Four Years). Average growth over the 2011–12 period is 3.4% compared with our expectation of 3.9%. The Treasury expects an average inflation rate of 5.9% between 2010 and 2012, while we see inflation averaging 6.1%. The improvement in growth expectations obviously benefits the key financial stability ratios such as fiscal deficit and debt.

2009/10 Budget Outcomes

The 2009/10 deficit is seen at 7.3% as a percentage of GDP, slightly better than the 7.6% expected during the medium-term expenditure framework, mainly because of a better-than-expected revenue outcome and some capital spending not realising. In the current fiscal year, consolidated government revenue collections is estimated at 657.6 billion rand (US$87.7 billion), 73.7 billion rand below budget and 4.7% lower than in the previous fiscal year. Expenditure is estimated at 835.3 billion rand, 1 billion rand more than budgeted and 17% higher than in the 2008/09 fiscal year. This brings the budget deficit to 177.8 billion rand (7.3% as a share of GDP) and 153.6 billion rand less than in the previous fiscal year.

2010/2011 Budget Estimates

For the new fiscal year, the minister budgets for consolidated revenue of 738.4 billion rand and expenditure of 907.0 billion rand. This leaves a fiscal shortfall of 168.6 billion rand, which translates into 6.2% as a percentage of GDP. He further commits to reducing the budget deficit to 5.0% and 4.1% as a share of GDP in the two following fiscal years.

Budget revenue as a percentage of GDP is expected to increase from 26.8% in 2009/10 to 28.0% in 2012/13, while expenditure as a share of GDP is expected to fall from 34.1% to 32.1% over the same period. Capital expenditure of 846 billion rand averages 7.3% of total expenditure over the next three years. Current payments, of which the government's wage bill is more than half, will average 59.7% of total spending. Transfers and subsidies to households, which include social grants, will take up more of total spending, increasing from 15.5% in 2009/10 to 16.2% on 2012/13.

Spending Priorities

Elaborating on spending priorities set out in the president's State of the Nation speech (see South Africa: 12 February 2010: South African President Renews Spending Commitment in Latest State of the Nation Address), more money will be spend on education, employment creation, and health. Education, according to Gordhan, remains the largest spending item, rising from 148.3 billion rand in 2009/10 to 189.1 billion rand (19.3% of total spending) in 2012/13. Health issues are to receive on average 12% of total spending over the next three years, with government looking to increase the use of public-private partnerships in this sector. This opens up interesting new investment opportunities for the private sector.

Employment creation is focused on the youth unemployment problem. The state intends to subsidise youth employment, thereby lowering the cost of hiring. Furthermore, the industrial action plan will focus on labour-intensive industries, while the state's public works programme will be extended. A total of 52 billion rand over the next three years is allocated to the employment-creation drive.

Financing the Shortfall

To finance the shortfall, government will borrow largely in the domestic market. Government net debt (excluding National Revenue Fund bank balances) is expected to double from the current levels of 690 billion rand to 1.3 trillion rand by 2012/13. As a percentage of GDP this will leave gross loan debt at 43.1%, up from 32.5%. This ratio is expected to peak at 44% in 2015/16. Debt-service cost is expected to escalate from 57.6 billion rand (2.4% as a percentage of GDP) in 2009/10 to 104.0 billion rand in 2012/13 (3.2% as a percentage of GDP). Foreign debt, however, is expected to constitute 11.8% of total loan debt or 3.8% of GDP in 2010/11. These ratios will be 10.8% and 4.6%, respectively, in 2012/13, implying no threat to the country's Sovereign Risk Rating. The overall debt ratios are also well below the Southern African Development Community (SADC) convergence criteria of 60%.

Macro Cornerstones to Stay in Place

A vital development to quell investors' fears included the minister's unconditional underwriting of the inflation-targeting policy of the South African Reserve Bank as well as the endorsement of the importance of a flexible exchange-rate regime. Inflation targets are kept at 3–6% with no intension of widening the Reserve Bank's mandate as it was already flexible enough to include employment and growth considerations. The significance of anchoring inflation expectations and reducing longer term costs in the economy was emphasised. Gordhan did indicate that he and the governor of the Reserve Bank had agreed that sharp movements in the currency will be countered through reserve accumulation, verbal intervention, and further exchange-control reform.

Other

To address environmental issues, a new carbon emission tax will be introduced on passenger vehicles from the third quarter of 2010 onwards. This could hinder the fragile recovery in the vehicle market.

Mining royalties will be introduced from 1 March 2010. This was postponed because of the recession in 2009. The tax will be levied on all minerals disposed of or exported. The mining sector's recovery is being restricted by high costs and a strong currency. The introduction of this tax could postpone much needed investment in this sector.

Outlook and Implications

Within a still-fragile economic environment, Gordhan managed to deliver a responsible, well-balanced budget. Of great importance for the country's Sovereign Risk Outlook is the commitment to reduce the budget deficits in the coming years. Economic development and growth potential are to be enhanced through spending on infrastructure and addressing employment shortcomings in the economy. By introducing measures to lower entry level wages and emphasising the need align wage growth with productivity growth, the government is starting to address structural problems in the labour market. Risks to the expected budget outcomes include lower-than-expected growth, should global growth falter for some reason. Spending targets could be jeopardised, should efficiency targets not be met. The risk of increased taxes in future is prominent if efforts to broaden the tax base do not deliver the desired effect, which will result in lower-than-expected economic growth. IHS Global Insight's fears of fiscal sustainability will hinge critically on all players in the government's commitment to keep recurrent spending in check.