South Africa should maintain expansionary fiscal and monetary policies "only for as long as is necessary", Finance Minister Pravin Gordhan said in his inaugural Medium-Term Budget Policy Statement (MTBPS) address to Parliament on Tuesday, in which he provided few signs of a material leftward shift in South Africa's macroeconomic trajectory.

However, he did hint to the possibility that taxes might need to be increased and to the need for greater coordination to deal with the current volatility and lack of competitiveness of the currency - both of which have been flagged as constraints by the Congress of South African Trade Unions and the South African Communist Party.

In addition, the MTBPS gave far greater emphasis to trade and industrial policy than had hitherto been the case, with a reinforcement of the already stated aspirations of scaling-up support for labour-rich industrial developments, as well as of the need to "calibrate" South Africa's tariffs to South Africa's industrial policy vision.

Gordhan indicated that higher taxes might be necessary to fund a possible "wage subsidy" and other labour-absorbing industrial incentives, as well as if the deficit, which was being funded through increased borrowings, is not gradually reduced as envisaged. The Minister also spoke of the need to not only broaden the tax base and improve compliance, but also of the possible introduction of new taxes, such as environmental taxes, to achieve both environmental and revenue objectives.

Should such higher taxes be introduced, it would be a significant departure from South Africa's recent budgetary stance, which saw a series of personal and corporate tax cuts being instituted over the past seven years.

But, despite these cuts, the country recorded a strong growth in tax revenue, supported by strong economic growth, as well as improvements in tax administration and compliance.

In fact, Gordhan, who was previously the commissioner at the South African Revenue Service, noted that, while economic growth had averaged 4,2% a year over the period of cuts, tax revenue grew by 7,8% a year in real terms.

On the other hand, the address also struck a chord for economic orthodoxy, with Gordhan asserting that the inflation targeting framework, despised by some on the left, was an important element in macroeconomic coordination.

"It has assisted in lowering inflation expectations, and in preventing inflation from undermining our competitiveness," he said.

The Minister also struck a business-friendly tone, despite the fiscal constraints facing him, by announcing further exchange-control liberalisation.

The proposed reforms included: allowing South African companies to invest in Southern African Development Community member states through offshore intermediaries; increasing the current R50-million limit for company applications to undertake outward investment to R500-million; the removal of the 180-day rule requiring companies to convert their foreign exchange into rand; the doing away with the R250 000 limit on advance payments for imports; allowing South African companies to open foreign bank accounts for permissible purposes without prior approval, subject to reporting obligations; and replacing the current paper-based monitoring system of exports with a more efficient electronic system.

DELICATE BALANCE

Overall, though, the statement, which was published amid South Africa's first recession since 1992, placed emphasis on the need to strike a "delicate balance" between using fiscal and monetary measures to stimulate the economy and avoiding the build-up of "unsustainable debt that will impose costs on future generations".

That said, Gordhan confirmed that the budget balance would shift from the marginal deficit position of 1% in 2008/9 to an expected deficit of about 7,6% of gross domestic product (GDP) in 2009/10, with State-owned enterprises and public-sector borrowing likely to reach 11,8% of GDP this year.

As widely anticipated, the new deficit figure was far worse than the 4% estimate provided by Gordhan's predecessor, Trevor Manuel, who is now Minister in The Presidency Responsible for the National Planning Commission. However, the estimate was better than some forecasts, with a few analysts warning that the deficit could be worse than 8% of GDP.

The stabilisation of expenditure growth in combination with a recovery in budget revenue was expected to result in the deficit declining to 4,2% of GDP by 2012/13.

But in financing the consolidated government deficit, borrowing by national government was now projected to reach R175,8-billion in 2009/10, declining gradually to R145,1-billion by 2012/13.

Net public debt would rise from its relatively modest level of 22,6% of GDP, R525,7-billion, recorded in 2008/9 to 41,1% of GDP, or R1 200-billion by the end of the period in 2012/13. During 2009/10, net loan debt would increase to R703,4-billion, or 29,2% of GDP, and rise steadily to 34,2% of GDP in 2010/11 and to 37,8% of GDP in 2011/12.

Foreign debt as a percentage of GDP would remain modest at between 4,2% and 5,4% over the period covered by the MTBPS.

By contrast, debt ratios in advanced economies are projected to rise to 110% of GDP by 2014 from 80% before the crisis.

SA TO START GROWING FROM Q4

Gordhan also provided a radically revised GDP growth estimate, reporting that government was expected to decline by 1,9% in 2009 - In February, Manuel forecast that the economy would grow by 1,2%.

" Positive GDP growth is anticipated in the fourth quarter of 2009, with growth of about 1,5% projected for 2010, reaching 3,2% in 2012," he said, indicating that, while public-sector investment would be robust, household consumption, the largest component of GDP, was likely to remain weak as households reduced their considerable debts.

The MTBPS was forecasting growth of 1,5% next year, followed by 2,7% in 2011/12 and 3,2% in 2012/13, well below the country's aspiration of 6% growth sustainable from 2010 onwards - a level seen as key to providing the platform for greater labour absorption.

Private-sector investment was only likely to recover in 2011, underpinned by higher commodity prices.

Growth prospects in Southern Africa and Africa, in general, remain relatively healthy, with growth of 4,1% projected for 2010 due to a recovery in investment in mining, petrochemicals, tourism and transport infrastructure.

But the slowdown had hit tax revenues, with tax revenue having fallen by about 3,2% of GDP since peaking in 2007/8, with the greatest declines in value-added tax receipts, company taxes and trade taxes.

Revenue was expected to fall to R657-billion, or 27,3% of GDP this year, falling from R692-billion, or 29,8% of GDP, in 2008/9. Expenditure would rise to R841,4-billion, or 35% of GDP in 2009/10, leaving a negative balance of R183-billion.

The MTBPS was forecasting higher revenue of R743-billion, or 28,4% of GDP, in 2010/12, climbing to R1052-billion, or 29,6% of GDP, by 2012/13, when the deficit should have fallen to 4,2%.

FISCAL SPACE

Nevertheless, Gordhan argued that South Africa still had the "fiscal space" to run a significant deficit in support of an economic recovery and employment stablisation and growth. South Africa had shed nearly 500 000 jobs since the onset of the economic crisis, with aggregate employment falling by 3,4% in the first half of 2009, with the highest ratios of jobs lost in agriculture, domestic work and the informal sector.

"However, over the medium term, a phased moderation of the borrowing requirement will be required," he added, noting that low levels of public debt have also enabled a rapid increase in infrastructure spending, with gross fixed capital formation by the public sector having increased from 5,9% of GDP in the second quarter of 2007, to 9,4% in the same period of 2009.

The Minister summarised the steps taken by South Africa to support the recovery as follows:
• Sustaining public spending and expanding public employment programmes;
• Supporting SoEs to raise their investment levels;
• Assisting sectors affected by the cyclical slowdown and bolstering municipal capital spending through the development finance institutions;
• Maintaining expansionary fiscal and monetary policies only as long as is necessary; and
• Reinforcing the social safety net.

"A sound fiscal position has enabled government to sustain public services, and to increase spending on investment that will raise our future growth potential," Gordhan averred.

He added that, over the next three years, revenue growth would recover gradually, while spending growth would have to moderate "to return the public finances to a sustainable trajectory".

PHILOSOPHY & POLICY

Outlining his philosophical approach to macroeconomic management, Gordhan argued that countries could not invest at a much higher rate than their savings could support on a sustainable basis, neither could countries nor households consume more than they earned for prolonged periods.

"For South Africa, this means that savings have to rise to be able to fund a higher level of investment," the Minister outlined.

However, he also stressed that rising income inequality would have negative social effects that could lead to economic instability. "Policy must focus on reducing inequality by creating more jobs, combating abuse of market power and broadening income security."

Stress was also placed on the need for appropriate regulation of the financial services sector, whose "unbridled excesses" led to the present crisis.

Gordhan also argued that government intervention was essential to protect the poor, to help prevent boom-bust cycles, to regulate financial markets and to support growth when demand falls.

"An effective and capable State is required to achieve these objectives," he asserted.

This philosophical foundation would be made practical through fiscal and monetary policies that "lean against the wind" to counter cyclical trends; through infrastructure investment; by keeping inflation low, which, Gordhan stressed, contributed to both growth and job creation; and through cooperation between the South African Reserve Bank (SARB) and the fiscal authorities to counter the effects of asset price bubbles on inflation, and to accumulate reserves to reduce exchange rate volatility.

On the exchange rate, Gordhan said that the "volatility and level" of the rand required attention, particularly because this affected investment in export-led industries.

The National Treasury and the SARB would "enhance [the] coordination of fiscal and monetary policy to support low inflation and a more stable and competitive real exchange rate".