Medium Term Budget Policy Statement: hearings

FINANCE PORTFOLIO & SELECT & JOINT BUDGET COMMITTEES
31 October 2006
MEDIUM TERM BUDGET POLICY STATEMENT: HEARINGS

Chairperson: Mr N Nene (ANC)

Documents handed out:
Nedbank Comments on Medium Term Budget Policy Statement
Industrial Development Corporation (IDC) Comments on Medium Term Budget Policy Statement
Industrial Development Corporation (IDC) Comments on Financial Results
ABSA Capital Comments on Medium Term Budget Policy Statement

SUMMARY
Nedbank said that there had been broader or more inclusive growth and Government policies had been redistributive. BEE had led to a rising black middle and upper class. Higher and more consistent economic growth was resulting in employment growth and strong disposable income growth. Overall, the investment drive was a bit late and investment was rising but was still inadequate. Skills had been insufficiently developed in key areas such as in engineering and other scientific areas.

Long-term growth should go higher with increased physical infrastructure, with capacity and skills development being key ingredients to this. The demand side of economy did not need any more stimulation and the pure economic response would be to raise indirect taxes.

The Industrial Development Corporation said that despite substantial progress on the economic front, the current account deficit was reason for concern. The medium-term outlook remained positive, with an average GDP growth of roughly 5% per year forecast for the period 2007 to 2009, supported by strong investment activity, a recovery in exports and fairly strong growth in private consumption expenditure.

One of the greatest challenges that faced the South African economy was its ability to create new jobs to reduce the extremely high levels of unemployment and to accommodate an increasing labour force. The key objective of the Accelerated Shared Growth Initiative for South Africa (ASGISA) was to halve unemployment and poverty by 2014. The main challenge was that in 2005, 4.5 million people were unemployed. If there were no additional increase in the labour force, then 249 000 jobs would need to be created annually just to reduce unemployment by 50% by 2014. They did not think that ASGISA was going to work.

ABSA said that for the first time since the early 1970s, South Africa’s growth was higher than inflation. The major economic challenges were poverty and unemployment, capacity and a lack of savings which was a major constraint to sustainable growth. Household spending was high but not wild.

MINUTES
Nedbank Comments on the Medium Term Budget Policy Statement (MTBPS)
Mr Dennis Dykes, the Chief Economist at Nedbank, said that the demand-side elements were largely in place. There was a more favourable global environment and strong, commodity-intensive growth driven by Asia. Improved policies had led to better ratings, which reduced the risk premium and the cost of borrowing. As a whole, the global economy had been strong and strong resources need had driven up prices with good medium-term prospects. Also, good policies and global deflation in certain prices had pushed inflation and interest rates lower.

There had been broader or more inclusive growth and Government policies had been redistributive. BEE had led to a rising black middle and upper class and higher and more consistent economic growth was resulting in employment growth and strong disposable income growth. Low interest rates had stimulated asset prices with a good personal income growth, a willingness to buy on credit and BEE had improved consumer purchasing power. Low prices, low rates, increased spending power and rising asset prices had helped the boom and significant plans are on the table to improve growth and investment.

The World Cup, the Gautrain and other largely cycle-insensitive projects would provide constant demand. Growth was accelerating, but performance in different sectors had been mixed. It seemed as though the supply side of the economy had been largely neglected. Capital formation was inadequate, transport and electricity concerns were now being addressed but this was a very late start and other public sector infrastructure had also been neglected.

Overall, the investment drive was a bit late and investment was rising but was still inadequate. Skills had been insufficiently developed in key areas such as in engineering and other scientific areas. Regulation was not always the best option. For example, there were mining rights conversion blockages. Taxation needed to address supply side, and one consequence of these failings was a rising current account deficit. This deficit had put pressure on the rand and created upward pressure on prices and interest rates.

Some of his conclusions were that the demand side of economy had been strong and prospects remained good. The supply side had been unable to respond due to a long period of neglect, modest expectations and delivery capability. Short-term growth was going to be hampered by physical and financial (the rand, higher inflation and interest rates) constraints.

Long-term growth should go higher with increased physical infrastructure, with capacity and skills development being key ingredients to this. The demand side of economy did not need any more stimulation and the pure economic response would be to raise indirect taxes. The regulatory burden had to be looked at to encourage any potential investors. A reduced tax burden was needed to encourage capacity growth in the private sector as well as to encourage foreign direct investment (FDI). These could be in the form of targeted incentives, but more preferable would be a strong cut in corporate taxes.

Nedbank's forecasts were similar to those of the Minister in his MTBPS, with slightly weaker global growth assumptions in 2007 and the reduction in the real interest was again encouraging.
The basic thrust of the policy was very logical and it was geared towards ensuring that macroeconomic imbalances do not threaten the economy, while at the same time addressing key issues. Space had been left open on the revenue side for appropriate tax relief and spending priorities were geared towards unblocking the constraints while at the same time maintaining a heavy social and redistributive bias.

Discussion
Mr Y Bhamjee (ANC) asked why local capital was reluctant to get involved in domestic investment when the opposite was true during apartheid. Even if corporate taxes were cut there was no guarantee that investment would follow. What did Mr Dykes mean by "successful 2010 from an economic perspective?"

Mr Dykes replied that in the 1960s there was massive internal investment which led to many inefficiencies and it increased in the 1970s because of the rise in commodity prices such as gold. There was a recession in the early 1990s but it was disappointing that there had been no real increases in investment. In part, this was due to low spending by the Government and the private sector did not take up the slack. For example, more infrastructure for electricity should have been constructed but was not. The economic success of 2010 would be seen in how well the country could host major world events and how attractive it was as a tourist destination. 2010 would be like a massive advertising campaign for the country.

Dr S Van Dyk (DA) asked why they were so worried about the balance in payments.

Mr Dykes replied that the global economy would slow in the next year and this would affect exports. They were not that worried as the current account deficit would narrow in the short-term and household growth would slow as well. Current account deficits became problems when investors decided to fund them at higher rates. This was not an issue in the long-term but there were some issues in the short-term.

Industrial Development Corporation (IDC) Comments on the MTBPS
Mr Lumkile Mondi, the Executive Vice-President of Professional Services, said that infrastructure investment should provide a strong platform for accelerated growth in the future. Government was promoting macro-economic stability, a favourable investment climate and increased economic opportunities. ASGISA aimed to lift the economy to a higher growth trajectory of at least 4.5% of GDP growth per year in 2005 to 2009, and a substantially higher economic growth of at least 6% per year from 2010.

Despite substantial progress on the economic front, the current account deficit was reason for concern. Growth in real fixed investment was expected to increase at a rapid pace over the Medium Term Expenditure Framework (MTEF) period to 2009/10. Substantial resources were allocated to key road and rail transport projects.
Against the backdrop of higher and sustained economic growth, the economy’s labour absorption capacity appeared to be improving as well.

There was also major investment in stadiums and public transport to ensure a successful 2010 World Cup. There also had to be a strengthening the criminal justice sector, with particular emphasis on visible policing and improving the court case flow. Investment in the built environment in the form of housing, roads, water, sanitation and community facilities had to be stepped up.

Investment in roads, rail, electricity generation and supply, dam construction and skills development would contribute to improved economic efficiency, accelerating the pace of growth, and the rate of investment in productive capacity. Regional and international partnerships for growth and development also had to be built.

The medium-term outlook remained positive, with an average GDP growth of roughly 5% per year forecast for the period 2007 to 2009, supported by strong investment activity, a recovery in exports and fairly strong growth in private consumption expenditure.

CPIX inflation had been within the 3 - 6% target range for three years (since September 2003).
However, increasing inflationary pressures had emerged since April 2006. Nevertheless, inflation was forecast to remain comfortably under control, peaking at 5.5% in 2007. Driven by robust economic growth and the increasing import propensity of the SA economy, the gap between imports and exports has widened substantially in recent years.

The current account deficit measured 6.4% of GDP in the first quarter of 2006 which was its worst level since 1981. Industrial and trade policy reforms were likely to bolster exports and moderate the trade deficit. Buoyant economic conditions were likely to result in tax revenue to be R29.6 billion more than budgeted for in the 2006/07 year. Robust economic growth would continue to boost tax receipts, resulting in revenue to increase as a share of GDP over the medium-term.
Prudent fiscal policy would also contribute to a continued reduction in Government debt and improve Government savings.

There had been a sharp reduction in overall Government debt since 1999. State debt as share of GDP was forecast to decrease to about 25.3% by 2009/10, contributing to lower debt servicing costs. Sound fiscal management had resulted in Government being able to lower the debt service cost by R10.2 billion in the 2005/06 fiscal year. By 2009/10 this saving in debt service costs would have increased to R25.6 billion. As an aggregate, more than R102.6 billion would be saved over the period 1996/97 to 2009/10.

There was going to be additional Government expenditure of R80 billion over the next three years. Provincial Government’s would also receive an additional R28.2 billion over the period 2007/08 to 2009/10. Education was to receive the largest contribution, with R103.3 billion assigned for the 2007/08 fiscal year (or 17.6% of total expenditure) which would be increased to R123.7 billion by 2009/10.

A reduction in interest expenditure was projected as its share of total spending declined from 9.8% in 2007/08 to 8% by 2009/10. Public sector infrastructure spending would amount to R409.7 billion over the next three years, compared to the previous amount of R372 billion.

In 2005/06, infrastructure expenditure amounted to R80 billion, and was now estimated to increase to R150.9 billion by 2009/10. Infrastructure expenditure by public enterprises accounted for 37.1% of the total, while Eskom and Transnet were expected to spend a combined R108 billion. The 2010 World Cup had been assigned R14.9 billion. Transport and water infrastructure investments include the Gautrain; King Shaka Airport and Dube Tradeport; De Hoop Dam and the Vaal River Eastern Sub-System Augmentation Project.

One of the greatest challenges that faced the South African economy was its ability to create new jobs to reduce the extremely high levels of unemployment and to accommodate an increasing labour force. Every attempt had to be made to achieve higher levels of economic growth of a broad-based nature in order to have a meaningful impact on poverty alleviation as well as to create and distribute wealth amongst all citizens.

Since 2004, the proportion of informal jobs has increased from 20% to 25%. The largest need for jobs was from people with no or little education (3 million jobs are needed for people with Grade 11 and lower). However, the SA economy had not succeeded in creating sufficient additional job opportunities in the formal sector, despite the relatively strong growth performance since 1994.

Contributing factors included: insufficient economic growth; unsatisfactory growth in new fixed investment; relatively high increases in labour costs; a structural change in the substitution of capital for labour through a substantial increase in capital deepening; the challenges businesses had to face since the country’s re-admittance into the global economy, trade liberalisation and globalisation.

The key objective of ASGISA was to halve unemployment and poverty by 2014. The main challenge was that in 2005, 4.5 million people were unemployed. If there were no additional increase in the labour force, then 249 000 jobs would need to be created annually just to reduce unemployment by 50% by 2014. Over the period 2001-05, the SA economy created, on average, 201 000 new jobs per year, of which 125 000 were in the informal sector.

This picture was, however, being distorted by a massive 658 000 new jobs created in 2005, the majority (410 000) of which in the informal sector. On average, 205 000 new jobs were likely to be created annually over the period 2006 to 2010. The labour absorption rate would increase to 43.5% by 2010 (39.8% in 2001). By 2010, the unemployment rate was then likely to be approximately 22.6%. By 2014, the unemployment rate would have been reduced to just over 19%.

To achieve the ASGISA goals, employment growth had to increase from an average rate of 1.6% per year to 2% over the period 2006-10. This would translate into an average annual number of about 250 000 new jobs per year over the five year period to 2010. Annual growth in employment had to increase substantially to 3.3% per year by 2014 and an average of 436 000 new jobs per year had to be created over the period 2011 to 2014 to achieve the desired goal of halving unemployment. If this task was achieved, the unemployment rate should be reduced to 12.8% by 2014. By 2014, 2.2 million people are likely to be still unemployed. Mr Mondi did not think that ASGISA was going to work.

The human development index (HDI) was a measure of a country’s economic and social wellbeing. The HDI comprised three equally weighted indices: the life expectancy index, the educational attainment index and the GDP index. The HDI ranged from 0 (the lowest level of development) to 1 (the highest level of development). South Africa ranked 120^th out of 177 countries in the HDI for 2003. In terms of the components of the HDI, SA ranked as follows in 2003: 150^th in the life expectancy index, 60^th in the educational index and 52^nd in the GDP per capita index.

At the provincial level, all nine provinces reported a deterioration in the HDI over the period 1995 to 2003, with KwaZulu-Natal, the North West and Limpopo reported the largest declines and the Western Cape experiencing the smallest HDI decline, at 2.6% over the period 1995-2003.
56.3% of South Africa’s total population currently lived in urban areas, and this figure was expected to increase to 70% by 2030. 30% of the population was concentrated in Johannesburg, Durban and Cape Town.

Between 1991 and 2001, the populations of these cities increased by between 21% to 40%.
40% of urban people lived in poverty and 54% of the unemployed were located in urban areas; 38% of people in the nine largest cities are unemployed and 25% of people in the nine largest cities lived in informal settlements.

It was estimated that eThekwini, Johannesburg and Cape Town alone accounted for 50% of South Africa’s GDP. 12% of South Africa's jobs were concentrated in Johannesburg, and the average income per household is R31 048, which was 57% higher than the average income per household for the country as a whole.

There was an increasing concentration of poverty and unemployment in the large cities and a shortage of housing led to increase in informal settlements. The challenge for local municipalities was to provide basic services to the urban populations. The inability to pay for basic services (water, electricity and sanitation) had increased and the increasing rate of HIV/AIDS in big cities was one of the greatest developmental challenges.

Over the period 2000-05, South Africa’s urban population increased by 1.43% per year. The urban population growth was expected to slowdown significantly, to an average growth rate of 0.33% per year over the period 2025-30. The fast-growing cities would drop back to stable growth due to lower urban population growth and the impact of HIV/AIDS. Official emigration had exceeded immigration since 1994, although the gap appeared to be narrowing due to higher immigrant flows and 84% of immigrants were not economically active.

Discussion
Mr B Mnguni (ANC) asked how the development programme was going to go forward if the IDC thought that ASGISA was not going to work.

Mr Mondi replied that the challenge in South Africa was local (municipal) economic development. Monitoring statistics needed to be improved. For example, there were cases where people got Government homes but then rented them out while they continued living in a shack. Improvements were being made but there was a lot to do before 2014. This required serious commitment and political will in the provinces and municipalities.

Mr K Moloto (ANC) asked what the key concerns of foreign investors were when they interacted with them. If tax rates were lowered, would that increase FDI?

Mr Mondi replied that the issues they raised did not have to do so much with tax incentives. They were concerned about the level of infrastructure in the country; how long it took to register companies; if property rights were protected; if there was enough capacity and skill in the locals and if there was competition in their sector or business. This was the area where South Africa struggled, especially in the cement and telecommunication sectors.

Mr Bhamjee asked for the definition of 'unemployment' and how it was measured.

Mr Mondi replied that the International Labour Organisation specified the standards and requirements to meet in employer/employee relations. According to them, the 'narrow' definition of ‘unemployed’ people was those who had been looking for work in the last two weeks and had registered their need for work. The 'broader' definition included those who had been looking for over two weeks and had given up. At present, StatsSA had this figure at 51%.

ABSA Capital Comments on the MTBPS
Mr Chris Hart, senior strategist in the Economy Strategy Unit, said that the country was under inflationary pressures due to the rand and the oil price but the pressure was expected to ease by the end of the year. For the first time since the early 1970s, South Africa’s growth was higher than the inflation. This favourable shift in the risk/reward profile would help to attract investors over the longer term. However, over the next year, the growth/inflation profile could slip back below the line should the rand not start to recover in the short-term.

Strong profit generation, economic growth and interest rate stability were expected to drive the economy. The commodity boom and the infrastructure rollout would be further drivers of the economy. Consumers, business and Government all had considerable capacity to increase credit levels. The growth cycle did not appear to have reached the stage of diminishing returns, which still suggests that there were a number of years before the current phase was exhausted. Developments in the property market and credit extension provided some evidence of this shift taking place.

In the region, there were three main drivers to change. In sub-Saharan Africa, the end of the cold war, the demise of apartheid and the commodity boom brought about improvement in governance and integration within the continent. Now the region had developed into a growth region, which was in contrast to a few years ago. Some of the prospects were economic growth exceeding expectations with economic conditions shifting as well.

The challenges South Africa was facing were a public debt level of 35% (which had a downward trend), an external debt of about 20% (with a downward trend) and a household debt level of 70% (which had an upwards trend). Debt levels were not a problem in absolute terms. Household debt was a problem and it was not one that interest rates alone could resolve.

High demand levels could be expected in an economy undergoing structural transformation. Balance would be restored when supply matched demand. This could be achieved by suppressing demand to match supply or by boosting supply to meet demand. Suppressing demand was the low growth option and would only prove to be a temporary measure. The long-term solution was to boost supply. This would involve a combination and co-ordination of official and private sector initiatives that made sense but could prove to be politically difficult.

The major economic challenges were poverty and unemployment, capacity and a lack of savings which was a major constraint to sustainable growth. It also placed too much reliance on FDI and credit.

He said that household expenditure was high but not wild. While the Reserve Bank was warning households to moderate spending, household growth was not at alarming levels. However, fixed capital capitation had been accelerating which could be one of the reasons for the current account deficit.

Some of the fiscal measures to fix this could be to shift the tax burden onto consumption and away from savings and investment. Also the overall tax burden could be lowered to below 25% of GDP. VAT could be raised and income taxes lowered but in such a way that the shift was transformed into savings. A greater portion of income could be shifted into pension provision through tax incentives and the Capital Gains Tax burden could be lowered also.

Some of the monetary measures could be aligning real interest rates with major trading partners, selectively applying reserve requirements for different debt categories, selectively accommodating different debt categories along with co-ordination with the Treasury. It would be useful to aim for a strong currency that held its value over time.

Some of the regulatory measures could be scrapping exchange controls and transforming the Department of Home Affairs to make it more functional in issuing visas for necessary skills. A policing/complaints policy could be drawn up with regards to the regulatory requirements. Also, the skills export policy had to be revisited. The shortened life span of the South African was a major economic drag. If anti-retrovirals or improved health care could extend the economically active life span by ten years, the difference to families was substantial. The social bottom-line report could include an approximation of the economic value added by an HIV program.

Discussion
Mr M Johnson (ANC) asked for Mr Hart's view on a weak rand.

Mr Hart replied that importers and exporters do create jobs but over the last 20 years of rand weakness no real job growth had been created. With a weak rand companies do become competitive but they also become less competitive because their focus would be on the financial side of the business and not on operational excellence. In this case there must be real confidence in the value of their products like in Japan.


The meeting was adjourned.