Medium Term Budget Policy Statement: briefing

Meeting report

JOINT BUDGET COMMITTEE WORKING GROUP
30 October 2002
MEDIUM TERM BUDGET POLICY STATEMENT: BRIEFING

Chairperson: Mr N Nene (ANC), Mr T Ralane (NCOP, ANC)

Relevant documents:
National Treasury presentation

SUMMARY
Maria Ramos, the Director-General of the National Treasury, made a presentation to the Joint Budget Committee on the Medium Term Budget Policy Statement.

MINUTES
Explanatory remarks on the presentation by Ms Ramos:
Ms Ramos explained that her presentation reflects how the Treasury understands what is going on in the global environment, how that impacts on South Africa, what that means in terms of them defining a revenue envelope over the next three years. The revenue envelope defines what is available or spending over the next three years and then allocating that spending to what has been identified as the key policy priorities of government over the medium term.

She said that the focus is on next year's budget but perhaps the focus ought to be on the outer years of the Medium Term Expenditure Framework. It is important for the budget reform process and the policies and the choices that have been made, to focus beyond the next budget in February 2003.

Introduction:
Ms Ramos said that the fact that they were able to revise growth upwards is an important development particularly given what is essentially a very fragile global economy. She reiterated the point made by the Governor of the South African Reserve Bank (SARB) and the Minister on the 29^th of October on inflation targeting, which is that they are not going soft on inflation. Inflation remains an important factor for us as South Africans and for the policymakers to be concerned about. The extension of the target is a reflection of the fact that the targets were not going to be met and it makes sense to broaden that band by 1%, which is not a lot.

Growth prospects:
Ms Ramos told the committee that in considering South Africa's growth prospects we also have to consider what is going on in the world. We have a very open economy and exports have become an important part of the economic story for South Africa and it will continue to be a growing part of that story. It is therefore very important to get a good understanding of what is going on in the global economy.

Ms Ramos said that a good understanding has been pretty difficult in the last two years, which makes it hard to predict where the global economy is going with a reasonable degree of certainty. She added that it is the second or third year in a row where she went to the IMF/World Bank annual meetings where the prospects for the global economy are deemed to be cautiously optimistic. There were several downward revisions to the economic outlook, for the US and also for the Euro-area and even for Japan during the course of this year. At these meetings a number of serious and quite important risks to the global economy was identified. Amongst those were the possibility of imminent war with Iraq and its impact on the global economy, the high oil prices, and the fact that serious amounts of value have been wiped of the equities market. The impact of that on the global economy and the US economy, which remains fundamental to global growth, was listed as some of the risks.

The Director-General added that coupled to the fragile US economy is the slowing down of the European economies, in particular Germany. The growth prospects for Japan remain quite bleak; it is predicted to grow about 1% next year with the US forecasts at 2.6% and the European economies expected at 2.3%. In that kind of environment global growth remains subdued. To that equation you have to add the fact that a number of countries in Latin America remain in trouble. We have now seen elections in Brazil. Brazil is a very big economy and what happens there reflects on the global economy.

She commented that the other side of the emerging market world is the Asian economies. This is an area where South African exports are beginning to penetrate. The Chinese economy in particular is continuing to grow strongly although it has let off a little bit. The growth prospects there remain quite good and it is the one area of the world where we are seeing robust growth.

This is the global picture South Africa had to work with according to Ms Ramos. For South Africa the growth prospects have been revised upwards not only because our domestic economy is doing well, but also because our exports are much more competitive and even though we are seeing a global slowdown, we are breaking into markets that we have not been able to break into up to now. This is partly due to the exchange rate depreciation.

Taking all this in consideration the Treasury felt quite confident that their growth numbers are not unrealistic. The numbers show a 2.6% growth for 2002 rising to 3.9% by 2005.

Sectoral growth:
Ms Ramos said that on the domestic level we have pretty buoyant growth across all the sectors of our economy. The agricultural sector has seen very strong growth in the first two quarters of the year, estimated at 6.1%. The manufacturing sector has also been doing well and within that the export sector has been strong.

Domestic demand:
She told the committee that consumption has primarily been driven by the R15 billion of tax reliefs this year. Some of that has of course been a little dissipated by the interest rate increases but the R15 billion was a big amount of tax relief and also that relief took place immediately, where the interest rate increases were spread out over the year. Disposable income is in good shape. There is a decline in household debts. So on the consumption side the picture looks quite good.

The investment picture also looks good according to the Treasury. There have been gross fixed capital formation rise by 6.7% in real terms for the first half of this year, driven primarily and quite strongly by private sector investment, particularly on the manufacturing side. Public organisations have also invested more strongly this year and even general government spending is beginning to have a positive on the investment picture.

Balance of payments:
Ms Ramos said that for the first time in a very long while a very small current account surplus is being projected. Equally important is the fact that the financial account has also done well. There have been net foreign direct investment for the first half of this year of R8.3 billion and even the bond market has done exceedingly well this year with about R16 billion of inflows on that market in the second quarter. All in all a surplus of about R21.7 billion is expected this year. That means the balance of payments is in pretty good shape. The fact that the balance of payments no longer poses the constraints in growth, as was the case ten, fifteen years ago is an important change.

Inflation:
The issue and the challenge South Africa faces are clearly around inflation according to Ms Ramos. The very steep and fast depreciation of the exchange rate in the last six months of last year has fed through into prices more strongly than initially anticipated. The oil price was also a very influential factor. The rise in the food prices has also contributed to the rise in CPIX.

Therefore the forecasts are not predicting the CPIX to reach the 3-6% target before the last quarter of next year. Expectations are that prices will stabilise and that the CPIX will peak soon and then come down quite strongly in the course of next year. The issue here is that high inflation has the worst effect on lower income households. That is why when decisions were made on the Medium Term Budget Policy Statement and this year's adjusted estimates were made, government was particularly concerned about the impact of inflation on poor households and it was decided to put additional resources aside to deal with that.

Employment:
The other part of the economic story is that on the employment side we are seeing some progress. The rate of job losses is declining. The Treasury feels cautiously optimistic that after eight years of big reforms in our economy we are starting to see the situation stabilise amid positive additions to job creation although clearly not at the pace we need, the same with growth. Growth has to be sustainable and happen as part of very big structural changes and reforms in the economy.

Exchange control:
Ms Ramos stressed that one of the things the Rand Commission said was that the gradual approach to exchange control was the correct approach. That supports the commentary and policy advice that has become mainstream, out of the IMF and the rating agencies. A gradual approach is better than a "big bang" approach. Not too many people are talking "big bang" approaches anymore. The world does not look like that any longer.

Fiscal Framework:
The Treasury's assumptions around how fast and by how much the economy is going to grow, basically sets the base for the fiscal framework. The important issue here is that the GDP in nominal terms is higher than anticipated. The estimated figure for revenue overrun is R8.1 billion is probably a little on the conservative side at this stage.

The expenditure side is well under control. We have seen strong growth in expenditure. In real terms expenditure is obviously not as high as was hoped because of the rise in inflation. Adjustments are being made to deal with the impact of inflation to maintain a good level of real growth.

Debt and Financing:
Debt service costs have declined significantly in the last few years. As indicated in Chapter 3 of the Medium Term Budget Policy Statement one of the things we have to take account of is the losses that arise from the Reserve Bank's intervention through the net open forward position. The Governor has indicated on the 29^th of October that the latest numbers on the net open forward position are $1.7billion. That is a very big improvement. It has come down from about $24 billion in 1998. Ms Ramos added that they have an agreement with the SARB that the net open forward position will be reduced to zero. The Governor did more foreign borrowing than he would normally have done to reduce the net open forward position from $4 billion in November last year. That means that the Reserve Bank's foreign currency debt has increased. Debt management has improved dramatically. There has been a decline in debt service costs to 3.9% of GDP.

Revenue estimates:
The Director-General told the committee that the National Treasury and SARS have a revenue estimation team between them. They have done a lot of work to ensure that their revenue estimates are as accurate as possible. Last year they were out by R15 billion. They thought they got it right this year but the higher inflation has made it more difficult. She emphasised that they do not deliberately underestimate the revenue. Every year they push the envelope a little bit and every year so far they have been proven wrong.

2003 Budget tax proposals:
Ms Ramos stated that normally no tax announcements are made in the Medium Term Budget Policy Statement as they are made in the budget. This time however they have given account of some of the areas that they have been working on. There will be some moderate personal income tax relief. The tax cuts that will be made will compensate for the impact of inflation incomes.

A workshop has been held with the retirement savings industry. They will not be finished in time for the budget next year but the work has started in this important industry.

The Mineral Royalty Bill will be introduced during the course of next year. There has been a lot of noise made by some analysts on this Bill. Ms Ramos said that as the Treasury they hope they have established a reputation of trying to do what is in the best interest of the economy. "Some of the stuff that is being written by so-called analysts at the moment is pure speculation". The Treasury knows that this is an important industry and what they do in respect of the Mineral Royalty Bill needs to be in the best interest of the country. That means it has to balance the interests of the industry, the importance of the industry in job creation, the commitment of the industry to black economic empowerment and the importance of that for overall economic development and the role of the state. There is the importance of recognising that when we talk about minerals we are talking about raising resources. We are not presuming to do anything in this bill that is not considered best practice internationally. An enormous amount of work has been done studying what other countries have done in this regard.

Discussion
The Chairperson thanked Ms Ramos for an elaborate, succinct presentation.

Q: Ms Taljaard (DP) said that there are number of areas she would want to comment on. She agreed that it is challenging to grow in a global economy with such uncertainty about where it is heading. She also agreed with Ms Ramos that a high growth rate is contingent on structural change. Ms Taljaard asked whether the pace of structural change has been fast enough. She expressed her concern on the forward revenue projections that flow from the proceeds of privatisation. She said that apart from Telkom the other projected revenues are comparatively low. Ms Taljaard compared the current inflation targeting to the process that was followed in Canada. Her question was why the SARB has not used the escape clause, although the Medium Term Budget Policy Statement stated clearly that the target would not be reached. She asked Ms Ramos to comment on the targeting framework itself and how perceptions have to be managed carefully.

Q: Dr Woods (IFP) said that for a number of years we have said that the fundamentals are in place. The signs are there that we go one step further to say that virtually all the essential macro-indicators are in place and seems fairly assuredly so. He asked the Director-General if we could go so far as saying that there is more promise that we are at the start of the stable growth path we sought for so long. He added that it seems to him that things are looking better than they have for some decades.

Q: Ms Hogan (ANC) commented on the projection of R7 billion loss of forward cover over the next for years. She asked whether Ms Ramos anticipates that the period of time will have to be extended by 1 or 2 years and what the implications are of loaning that money given the exchange rate fluctuations/interest rate movements.

A: Ms Ramos started with the issue of privatisation and the proceeds. She said that the Treasury has taken a cautious approach as to what the revenue streams over the next few years look like on the privatisation front. The cautious approach is primarily because the Telkom IPO is going to be, for the foreseeable future, the biggest portion of the privatisation program. Although there are other areas, like the transport sector and Eskom, there is not yet clarity that those restructurings are going to take the form of IPOs. It is also not clear what those potential revenue streams look like. Another reason for being cautious is that it is difficult to get a handle on the global markets right now. Everything is on track to do the Telkom listing in February, but the Treasury is realistic in understanding that these are difficult markets to do listings in. The volatility in the global economy in this particular sector makes for difficult calculations. She added that obviously more proceeds from privatisation would reduce the net open forward position.
She reminded the committee that the net open forward position was very large ($24 billion in 1998). That meant that there was always going to be a mixture of foreign borrowing and proceeds from privatisation to reduce the net open forward position.

On inflation targeting she said that the framework is there and that it includes the escape clause, which is to be triggered if they think that they need to trigger it. The agreement to extend the 3-6% target by one extra year was an agreement between the Minister of Finance, with the backing of the cabinet, and the Governor of the Reserve Bank. The agreement is that this is the most appropriate strategy at the moment. The triggering of the escape clause is an autonomous decision by the Reserve Bank. She added that one of the main benefits of inflation targeting is that it begins to impact on people's expectations. It brings certainty and creates an environment within which monetary policy decisions have a specific set of objectives. The objective is to bring inflation down to within that band. That is the key objective of monetary policy. From that perspective the Treasury believes that inflation targeting is the right approach for monetary policy for South Africa. She mentioned that in the Medium Term Budget Policy Statement there is mention of other countries that are missing their inflation target this year including Australia, New Zealand and Brazil. Ms Ramos added Sweden and Canada to the list. Missing the inflation target is not unique to South Africa or the South African Reserve Bank.

Replying to the question should they not be more positive, Ms Ramos agreed in principle and added that they are trying to be more positive by revising upwards the growth and by budgeting for strong growth in real spending. This is a clear indication that the Treasury feels that on the fiscal side the fundamentals are now firmly in place. It has taken 7 years of hard work for the whole country to get to this position. These are very difficult and painful adjustments to make. We are moving from an environment where we have debt positions that can quickly become unsustainable to debt positions that are sustainable. It is quite easy to lose that position and the hard work will have to be maintained.

On the issue of forward cover Ms Ramos said that these accounts are for both profits and losses. There have not been too many profits on the foreign exchange operations for a while. In 1996 the balances of those forward accounts actually paid off. In 1997 those accounts had a small positive balance and then as the net open forward position blew out in 1998 and because the exchange rate has depreciated, the losses of that account have built up over the years. The R28 billion, as of the 31^st of March, is therefore accumulative balance on that account. Paying these losses of in one year instead of the current schedule of four years is not going to affect us from an exchange rate point of view. She added that there is only one way to end this situation and that would be for the SARB not to be in the forward market. She added that the SARB is not the only central bank in the world that plays in the foreign exchange markets or even in the forward markets. The objective here is to get out of this market and once you are out to stay out.

Mr Brian Molefe (National Treasury) answered the question on privatisation. He told Ms Taljaard that it is not entirely correct to look at the size of privatisation proceeds and then making assumptions on the pace of privatisation. He said that when you look at what has been sold of in the last six years, about fifteen transactions, you would see that largely they were very small companies of no strategic value. Privatisation proceeds since 1997 amounted to R27.5 billion. The sizes of the transactions were mostly very small like for example Connex that was owned by Transnet was worth R11 million. A more substantive debate on the restructuring of state assets would be which entities are being looked at and why are those entities being sold from a strategic point of view.

Q: Dr Rabie (NNP) commented that in the Medium Term Budget Policy Statement the exchange control changes with relation to Africa. He added that South Africa corporates are becoming global players. He wanted to know whether the concessions would be extended to the other continents.

Q: Mr Mnguni (ANC) asked for more clarity on how tax cuts in a fiscal expansionary regime will affect the achieving of the inflation target.

Q: Mr Theron (DP) said that he has a very high regard for the work the Director-General and others have done over the past 6 years. He asked if there is anything more that could be done to make prevent rapid depreciation of the Rand and to curb inflation.

A: Ms Ramos answered that the process of exchange controls is an ongoing process and the Treasury felt that this was important to do now. It is of course important for South Africa companies to internationalise. We have seen a lot of internationalisation and opening up in the last few years. If you look at how many South Africa companies operate on the global stage it is quite significant. She reiterated that this is an ongoing process and they are in the process of evaluating what to do next. They will definitely give it a lot of consideration in the future. The relaxation of exchange controls for Africa is also a response to the commitment of Nepad and African investment.

On the expansionary fiscal policy and how it affects the inflation target Ms Ramos remarked there are a few things we have to remind ourselves. She stressed that the increases we have seen in inflation this year has not been driven by domestic policy choices. It was not the R15 billion tax cut that caused the high rise in inflation. Exogenous shocks were the main drivers behind the rise. The depreciation of the exchange rate did not occur because of there was a major misalignment of domestic fundamentals. It occurred in an environment where the major market economies and the global economy was pretty turbulent and volatile. A lot of what is happening to inflation this year has been for reasons outside the domestic economy. We have to be cautious to assume that an expansionary fiscal policy is automatically inflationary. The increases in government spending are not being financed by significant increases in government borrowing. Government is not increasing the deficit dramatically, is not putting pressure on domestic capital markets and is not putting pressure on interest rates. We are able to do the expansion on the fiscal side after many years of assuring that fiscal spending is actually being trimmed and assuring that it is effective and efficient. It is not the salary bill as a percentage of government spending that is increasing. The Treasury feel that the fiscal policy is very responsible. She said it was important to bear in mind that wages have been moderate considering where the inflation has been this year.

On the volatility of the exchange rate she remarked that we have a floating exchange rate that responds to what is going on in the world. She said that 15%-18% of South Africa revenue debt is being held by foreigners. She added that when you consider the importance of exports you have to realise that the exchange rate is going to fluctuate. It is part of being in the global economy. Your best insurance policy is sound macro-economic management. The fact that they were able to revise upwards the growth numbers is testimony of the incredible resilience of our economy. She referred to 1998 as an example of the significant costs associated with trying to defend the exchange rate.

Q: Mr Mohlala (ANC) commented that when one looks at the depreciation of the currency it is usually attributed amongst other to the global slowdown and reduced demand for immediate market assets. He then asked whether it is not therefore logical that the appreciation of currency should actually be attributed to the opposite of these negatives responsible for the depreciation. He also wanted to know what the impact would be that the recovery of emerging markets would have on the appreciation of our currency.

Q: Ms Hogan asked Ms Ramos to elaborate on the assumptions underlying what allows the government flexibility to increase spending.

Q: Mr Theron asked the Director-General about local government debt and investment. He commented that a lot of the new demarcated municipalities are struggling with huge debt, which is forcing them not to be able to make huge investments in infrastructure etc. He asked whether the new allocations are sufficient to start making bigger investments in economic growth.

A: Ms Ramos replied to Mr Mohlala that nothing in economics is what it seems. She said that when we see an improvement in appetite for emerging market assets and when foreign investors buy South African equities and bonds, it has a positive impact on the currency. It is important to remember that it is not just about the Rand. A lot of this is driven by what is happening in the US, UK and Japanese economies for instance. If the Dollar appreciates the Rand depreciates and vice versa. She said that part of the current debate, even at the IMF, is whether there should be more focus on the economic policy choices that are made in the big economies. Those choices have a very significant impact on the rest of the world.

She said that one of the factors underlying the increased spending is the fact that better growth is expected. A good performance on the revenue side and the downward trend in debt service costs are other factors that create space for the additional spending over the next three years.

On the allocations to local government, she commented that they do not constitute the largest portion of revenue in local government. The largest portion of revenue in local government comes from local taxes. The equitable share is in fact just a small portion of the revenues that go to local government. The equitable share is really focussed on making provision to support infrastructure, particularly to low income households. The Treasury is aware that some Municipalities have unsustainable debt positions. Building capacity at the municipal level needs to be done more and more. The Municipal Finance Bill will provide a better financial management environment at the local government level. She stressed that they are not making provision to pay of debts of municipalities. Giving money to a local government who do not have the capacity to spend it effectively does not help anybody.

Q: Mr Ralane (ANC) asked about the additional allocation of R3.8 billion for unforeseen and unavoidable expenditure of which R2.3 billion goes to provinces. Mr Ralane asked whether it is necessary to give provinces this money in the context where some of them have contingency reserves.

A: The allocations to the provinces are done on the basis of the equitable share. The Treasury did an assessment and worked closely with the provinces. The provinces are under pressure. The increase in numbers of claimants on the social grant side has been quite significant. Some of the provinces are facing a rate of up taking on the support grant that they could not have anticipated. The same applies to the disability grant. A lot of work has been done to make sure that the financial positions of the provinces are sound and sustainable. We are currently seeing acceleration in the provision of infrastructure at provincial level.

The chairperson thanked Ms Ramos and the National Treasury for their presentation and congratulated them on their hard work.