Budget hearings: Macro-economic perspective

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Finance Standing Committee

26 February 2002
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FINANCE PORTFOLIO COMMITTEE
27 February 2002
BUDGET HEARINGS: MACRO-ECONOMIC PERSPECTIVE

Chairperson: Ms Hogan (ANC)

Relevant Documents
Presentation by Nazmeera Moola - Merrill Lynch
Presentation by Andre Roux - Investec
Presentation by Goolam Ballim - Standard Bank

SUMMARY
Three economists presented their macro economic perspective on the Budget. One submitted that the R15 billion tax relief might not be as robust as expected because there is still uncertainty around inflation and interest rates. All the economists were positive about the economy but did alert the Committee to a few potential problems. All economists concurred that there will be a 1% interest rate increase.

MINUTES
NAZMEERA MOOLA - MERRILL LYNCH
Ms Moola spoke on growth and inflation and how monetary and fiscal policy impacts thereon.

On what the fiscal policy offers us, she said that it was positive that people earning less than R150 000 got 57% of the tax relief. The R15 billion tax relief is equal to a 400 bps cut in the interest rate. The Budget signals a period of consolidation that provides certainty to taxpayers and a stable platform for investment and economic expansion.

She predicted that demand in the economy will stagnate into next year and growth will therefore be dependent on exports and government spending. If either fails to materialize, then growth can easily slip to 1.5%. She did think however that the 2.3% growth predicted by government was plausible.

Currently there are four strong sectors driving growth. The first is the manufacturing sector. This sector is expected to do better in the better second half of the year because of exports. There is a concern with the other 3 sectors though. The Communication sector's growth is largely due to the coming on line of Cell C and this trend cannot continue. The wholesale, retail and leisure sectors were boosted by motor vehicle sales as a result of pre-buying. Consumers feared the price hikes in the new year. This sector will therefore experience a significant slowdown in the new year. The financial sector is a mystery and there is a concern about growth in the first half of this year.

A notable factor is that exports comprise a far larger proportion of growth and this takes up even more importance when one considers where domestic demand is heading.

On inflation she said that it would show an upward trend until September. The average will be around 7% maybe a bit lower. She predicted that next year the average will be at 6% and was of the opinion that it was not a sure thing that the Reserve bank will meet the inflation target for next year. She added that an increase in the interest rate would not help in reaching the target.

In respect of food prices she said that legally there is no control of food prices. The producer food prices went drastically due to the maize prices. This year there are signs that the maize harvest is far healthier and she predicted that the maize price would come down. At the end of the day there will be very little of the price increase passed from the producer to the consumer.

The Rand oil price is far higher than it was in 200 and the $ oil price is far lower than it was in 2000. Going forward the price of petrol will do well. If the oil prices do go up it can be argued that the Rand is well correlated to the global industrial cycle so if the oil price goes up in $ terms the Rand will strengthen to offset the increase.


On interest rate policy she said that it was steady notwithstanding the recent increase.
She said that in SA demand does not drive inflation. For this reason a change in the interest rate will not help. She said that the rate will be increased but it should not be. An increase will curb demand driven inflation, which we do not have.

Discussion
Mr Moloto (ANC) asked what measures could be taken to stimulate domestic demand. He also wanted to know if an over reliance on exports was dangerous for South Africa and what the impact was of tax cuts on domestic demand.

Ms Moola replied that the problem with domestics demand is that government cannot do much more. The tax has already been cut and now stability in interest rates and exchange rates is needed. The latter two the government has little control over. It is a question of putting in place long term growth policies to bring exchange rates down and in consequence increase confidence. Currently consumer and business confidence is at a low.

The impact of the tax cuts is that consumer demand will still be slow but will not be as shallow.

Other emerging markets have much more volatility in growth. One year it is 6% the next -1%. But the average rate is higher than ours is. SA does have a problem with growth. There is low consumer demand and as a result investors will not buy into non-resource companies.

Mr Andrew (DP) asked if there was a danger that fiscal and monetary policy was moving in different directions. He commented that the presenter had said that she was not in favour of an interest rate increase because it would not curb inflation.

He asked if after the election in Zimbabwe if the Rand would improve and also wanted to know if there was a definition of economic fundamentals. Was it growth rate, unemployment the deficit, etc.

Ms Moola replied that there is divergence between monetary and fiscal policy. Monetary policy controls inflation and fiscal policy stimulates growth. She submitted that at the moment the two are working against each other and reiterated that the interest rate should not go up.

To his second question, she replied Merrill Lynch has built into their forecast that there will be no anarchy in Zimbabwe and no civil war. She said that there can be no more bad new coming form that country. Using the arrest of Tsavingarai she explained the event had no impact on the Rand. Short of civil war nothing should cause the Rand to deteriorate.

In response to the last question she said that there is no simple definition of what is fundamental. It depends on what is the flavour of the month and it changes from time to time. At the moment inflation is not a concern to investors who are more interested in the growth rate.

Dr Koornhof (UDM) asked the presenter if she knew the projected volume of the grain harvest, if it was sufficient for local consumption and whether SA has the capacity to export part of the harvest.

Secondly, he refereed to the prediction that the Rand would improve and asked what other factors were taken into account apart from no civil war erupting in Zimbabwe.

Ms Moola replied that she spoke to a food analyst at her firm who called the mills and indications are that that there is enough for local consumption she did not however have the figures as to the volume.. She said that SA does have the capacity to export and it has in the past.

Two important factors built in to the recovery of the Rand is a US and European recovery. She commented that the German IFO numbers released yesterday suggests a V shaped recovery for Europe.

Prof. Turok was puzzled by the difference in the growth rate of our country and other emerging markets. He asked what is Merrill Lynch's conclusions on what must be done to change perceptions.

Secondly he said that he found the emphasis on demand by Ms Moola unusual because everyone is talking about supply. Industry is performing at 80% capacity and this indicates that there is domestic demand because industry largely supplies the domestic market.

Finally he wanted to know if her firm did an analysis of spending in SA.

To the first question Ms Moola replied that domestic companies have no confidence in SA. She commented that international companies often asked her why must they have confidence in SA when domestic companies have no confidence. She referred to a graph by a colleague that shows that the cash on the balance sheets of companies is growing and this shows a lack of confidence.

In response to the second question she said that demand is emphasised and not so much supply because personal consumption expenditure is an important element of growth.

On capacity she replied that her firm has not done work on spending capacity.

Mr Mguni (ANC) was sceptical about the inference that because there is cash on the balance sheet it means that confidence is low.

Ms Moola replied that is a reasonable assumption. Either there is a lack of confidence or a lack of investable opportunities. The opportunities are linked with risk and if there is confidence the perception of risk is lower.

Mr Ralane (ANC) commented that t was governments mission to fight poverty and wanted to know what can government do if food prices goes up. He asked if government should regulate prices, subsidise them or zero rate.

Secondly, between 1994 - 1999 there was no Zimbabwe issue and confidence was still low. The member wanted a reason for that.

Ms Moola replied that food prices should not be regulated because it has negative consequences like black markets and a decease in supply. She said that subsidies could be an option and that many goods were already zero rated.

Zimbabwe is not the only reason for a lack of confidence. Her own view is that in 1994 business looked at SA and thought that in 20 years time it will look just like another African country.

Ms Hogan commented that when the Governor of the Reserve Bank comes to the Committee he as it pains to explain that an interest rate increase is necessary to curb inflation and that it should be done immediately. She referred to ms Moola's comments when she says that the interest rate should not be increased because SA does not have consumer based inflation. Hs Hogan commented that the Reserve Bank would be in a dilemma because if it does nothing it is seen not to be acting and if it does act that it is seen to be acting contrary to fiscal policy.

Ms Moola replied that the impact of the interest rate hike on inflation must be questioned. She said that this years inflation target is lost but next years target remains an issue. Raising interest rates will not effect inflation and it is not a good argument just to raise it because of perceptions. If demand inflation is coming through then there is a good reason to raise the rate.

Ms Mahalangu (ANC) asked why there was so much investment in Angola considering the situation.

Ms Moola replied that there could be opportunities that have yet to be exploited. Most have been exploited in SA.

Ms Hogan asked if the Myburgh commission will shed any light on the depreciation of the Rand.

Ms Moola replied that speculators might be identified but the underlying reasons for the depreciation will not be uncovered by the Commission and for this reason nothing useful will come from it.

An ANC member asked what parliament could do.

Ms Moola replied that the clear communication of policy is important. An example is the HIV / AIDS situation that did hurt SA.

ANDRE ROUX - INVESTEC
Mr Roux's main focus was on the macro - economic background of the Budget and the possible impact of the Budget thereon.

He said that it was an exceptional Budget and that SA is in a fortunate position unlike many other countries to cut taxes and increase expenditure so rapidly. The tax cuts were so huge that what government expects to get from the taxpayer decreases in Rand Value.

The Fiscal record is impressive in that government consumption expenditure is contained, there is a reduction in government dissaving, reduced interest expenditure and reduced public debt. Two not so impressive factors is that capex has not grown and the tax to GDP ratio has risen due to the excellent collection. The tax cuts therefore shows government intention to stabilise the ratio.

He makes the following points:

- The global industrial productivity is a poised for a recover and this should lift commodity prices. It is unclear how strong the recovery will be but all the signs indicate that that there will be an improvement for SA commodities.

- GDP will slow but will bounce on the back of a global recovery. GDP will not fall as far as the rest of the world because the SA economy is resilient. Exports have been recovering over the past few months and a global recovery will benefit SA.

- Rand depreciation effects consumer confidence. It was submitted that consumer confidence will deteriorate. To understand hat is going on in SA macroeconomics the role of the Rand is important. The ups and downs of the Rand is a key factor for consumer confidence. Consumer confidence is linked to an underlying political cycle. In the 1980's black consumer confidence was at a low. In 1994 it exploded. White consumer confidence was steady in the 80's and to the lead up to the election it deteriorated. There was further deterioration after the 1994 elections. In 1998 there was a downward turn in whites and black consumer confidence and the reason for this is not clear. Black consumer confidence makes up 55% of the total index.

- Consumer confidence is affected by borrowing and interest rates. Confidence determines how much to borrow. Consumer confidence affects mainly durables like cars. hi-fi's etc. It was submitted that consumer confidence will soften even though rates are still low. Durable consumption has not collapsed because nominal interest rates are relatively low. It was stable since 1998 and gradually drifting down.

- Non - durable consumption is more closely linked to remuneration. A real remuneration slowdown in 2002 will result in poorer performance of non - durables.

- The income tax cuts fully offsets the negative impact of rising inflation. In this way the Budget is significantly expansionary and could not have been timed better.

- After 1995 the growth rate of private investment is not as bad as people say. Clearly everyone would like more. There was a decline in 1998, probably because of the delays in privatisation. Going forward private investment will weaken. Low interest rates will help investment.

- There was a real collapse in government spending in 1997 and 1998. In this Budget it explodes off the graph. The Budget does imply massive growth but the challenge in the financial year is to accelerate investment.

- Export volumes will rise as the global economy recovers and the Rand effects kick in. Net exports will provide growth in the economy. Most analysts will revisit their growth forecasts for the year. It was submits that the government rate of 2.3 is achievable.

- Import and export prices will accelerate and the Rand should boost export values even more. The relative performance of exports and imports is important. If export prices increase and import prices increase as well there is a problem. If the value of imported goods rises faster then there will be a deficit on the trade account. It was submitted that there should be a relative growth of exports and the depreciation of the Rand will be good for the trade account.

- Offsetting the good export position is dividend outflows that coincide with high company earnings. The Rand depreciation means a bumper year for resources companies and therefore there will be lots of outflows.

- The net effect however of the impact of the Rand on exports will comfortably finance the acceleration of dividend outflow. The current account will therefore be in positive territory.

- This year the Rand is expected to remain stable as the global economy recovers.

- When SA is compared to other emerging markets that have experienced crisis and then recovery it is consistent to forecast that over time the Rand will recover from extreme losses.

- Inflation will miss this years target but will meet the target next year.

- Underlying inflation which excluded food price and transport costs looked good at the end of December last year and therefore government was confident. But because of the Rand, inflation will accelerate sharply in 2002.

- The depreciation of the Rand is not the only reason for sharp acceleration of agricultural products. The price of maize normally hovers between the import price and the export price. The import price being higher due to tariffs the exchange rate etc. last year the maize price was closer the export price. The depreciation of the Rand drove the export and the import price up. In 2001 the maize price went up towards the import price by factors other than the Rand.

- Food price rises are the major risk to inflation this year. Food price increases cannot be avoided this year.

- The unit labour costs still point to a favourable medium - term inflation outlook. The long term inflation outlook has not deteriorated therefore the inflation target will be met next year.

-Interest rate increases are unavoidable.

In conclusion Mr roux commented on Ms Moola's comments on the divergence of fiscal and monetary policy. He said that the two are different. Fiscal policy is about long term goals like sustainable growth and a predictable tax regime. Monetary policy on the other hand is about short term managing of the monetary cycle which the Reserve Bank must do.

Ms Hogan asked that Mr Ballim present and questions could be fielded to both economists.

GOOLAM BALLIM - STANDARD DANK
Mr Ballim said that one feature of sound fiscal management is flexibility. Worldwide governments are expected to inject growth into the economy but globally there has been a downturn in GDP. SA imports all types of things but there is no flexibility to adjust and produce the goods locally. Therefore SA will continue to import but at a higher price.

The South African economy does have room for fiscal stimulus and is better placed than other developing countries.

The tax relief mainly goes to households that consume. The middle income earners. One could even argue that significant tax relief to upper income earners could result in an outflow of capital.

Consumer spending is healthier than it was last year due to the favourable interest rate. Household spending in relation to GDP has remained stable but the spending is mainly financed by debt. Nominal interest rates are lower now than in the past 10 years, it is half what it was 4 years ago. It is nominal interest rates that effect consumers.

Mr Ballim submitted that the Reserve Bank is concerned with wage spirals and therefore it will increase the interest rate. The main concern of the Reserve Bank therefore is that inflation pushes up wages. He submitted that wages will probably increase by 9%. Many firms link the wage increase to the CPIX. Some fix it at CPIX plus 1%. The Minister has got R3 billion Rand in contingency reserve for the wage increase. The minister expects that the CPIX will come in at 6.9% as opposed to Mr Ballim who predicts a CPIX of closer to 7.8%. This will put pressure on wages.

Because of the wage increases and the decrease in productivity Mr Ballim does not agree with Mr Roux on the nominal unit labour cost and says that this will increase.

If the increase wages pushes up the general price level then this could inform future wage negotiations and this the Reserve Bank wants to pre-empt.

Because there is a threat of an interest rate hike spending will be effected. The R15 billion tax relief will be used to reduce household debt. Any benefits will only come later after stability around inflation and interest rates. For this reason Mr Ballim submits that the tax relief will probably not be so robust.

On investment he said that the Public Service constrained investment as rather than private business. The 11% increase in capital expenditure over the MTEF period is welcomed but it is from a low base. Private investment will accelerate when it is underpinned by robust infrastructure investment by government. He submitted that government risks reputational damage if the promises in the Budget are not delivered. An example is the Telkom IPO. The same can happen with infrastructure spending if the Budget is not fulfilled.

He said that private sector investment rebounded after the emerging market crisis but that it was not nominal rates that drive this sector but rather real interest rates that were still high.

In conclusion he said that the reserve bank will increase interest rates by 1% but he was not sure how far they have to go to prevent wage spiraling.

Discussion
Prof. Turok commented that the Budget deficit surprised everyone and wanted to know if it was not planned or not understood.

Mr Roux replied that SARS is cautious in its estimation of company tax because it is very unpredictable. Last year company tax delivered. Most years estimates of other taxes or not far off but last year companies paid a lot more tax. In the current year good company earnings is predicted but one must be cautious with company tax because it can be grossly overestimated as well.

Mr Ballim added that at last years MTEF hearings he did predict platinum mining would contribute R3 billion extra because of the high prices and ventures to suggest that at least R10 billion extra would be collected. All of the overruns can therefore not be a surprise.


Mr Ballim replied that banning the import of luxury goods is not looking at the underlying causes of the problems. It will not be a good idea because SA is liberalising its economy and that measure does not fit in with broader policy.

Mr Ralane (ANC) commented that both economists said that government does not invest in the economy. He was of the opinion that it was private business that does not do enough. He asked what informed their opinions. He gave examples of his constituency where mines closed and there was no investment from private business. on the other hand government does a lot for the poor.

Mr Roux replied that it was indisputable that the future of mining companies is difficult to anticipate. Until a few years ago SA mining was under a lot of pressure and the situation only changed recently. All that he and Mr Ballim were trying to say was that the perception of an interest strike was exaggerated. Government investment has been disappointing and here is no doubt that the same is true for the private sector. At the end of the day the growth rate in SA is 2,3 % and the investment is not deficient to sustain this level of growth. The question is how do we get away from this. If SA can reach a rate of 4% for 2 - 3 years then there would be a change. He submitted that it was the investors right to say that growth is 2.3% and therefore they will invest at that level.

Mr Kannemeyer (ANC) refereed to Ms Moola's submission that an interest rate increase will not assist in combating inflation.

Mr Roux replied that there are various elements of inflation. Some elements are domestic and is not influenced by the Rand or global trends. The cost of services in respect oh health and education for example is domestic and not influenced. Other goods like fuel is totally influenced by the Rand. The basket of elements has to be unpacked and examined and he was sure that the Reserve Bank does do this. Food prices is also sensitive because it cab be traded. Everyone struggles with what the second round impact of inflation is. The first round is easy to calculate.

If the second round effects pick up it is harder to get out of the system. The Reserve will try to do something about the second round effects. In January the Reserve Bank showed that it was serious about the inflation targets sending the message that this must be borne in mind when working out food prices going forward. He submitted that we must be pre emptive but that it would be a pity if the economy is constrained to reach next years targets. He said that we are not yet at that point but the Reserve Bank is just signaling that it is serious about reaching the target in 2003.

He said furthest that SA has enjoyed unprecedented interest rate stability and that there ill be a time where things go wrong like at the moment. We cant step back and say that the target is a joke because then the benefits of stability will evaporate and there will be a return to monetary and interest rate instability.

He concluded by saying that there will be a 1% increase in the interest rate, the target will be met next year, the reserve Bank will be seen to be taking the target seriously and later everyone will look back and see that there was no major policy mistake. He added that he could be wrong.

There were no further questions.

The meeting was closed.

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