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Nene spreads pain between spending cuts and tax moves

24 October 2014   (0 Comments)
Posted by: Author: Hilary Joffe (BDlive)
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Author: Hilary Joffe (BDlive)

Austerity is not the word one would apply to Wednesday’s medium-term budget, if it’s compared to the austerity budgets of Europe or the UK, for example. In the latter, the government is busy cutting per-capita spending on public services by almost 25% in real terms and wants to eliminate the fiscal deficit.

Yet the budget Finance Minister Nhlanhla Nene presented on Wednesday went further than almost anyone expected in doing what is needed to stick with the deficit targets set out in the February budget, despite much weaker economic prospects — and even though, as the budget review itself acknowledged, the fiscal framework could "dampen growth".

With expenditure still increasing 1.3% in real terms over the next three years, this may not have been austerity, strictly speaking, but it was certainly a change of fiscal course, with Nene pencilling in R25bn of spending cuts and R27bn of tax hikes for the next couple of years in a bid to stabilise the public debt and restore the fiscal space that has been lost in the six years since the financial crisis.

"Fiscal consolidation can no longer be postponed," Nene said in a speech with little to offer in the way of rhetoric. It promised mainly to re-establish a sustainable foundation for public finances that would lower the cost of capital across the economy and "open the way for investment-led growth" — and so support economic growth in the future, if not necessarily now.

So why did Nene do it? How did he do it? Will it work? And what are the risks?

Many had expected that he would struggle to impose fiscal discipline on his colleagues, but this budget was, apparently, relatively easy in the sense that the main decisions had been taken in the Cabinet over the past couple of months. And Nene was careful to emphasise that the Cabinet "collectively owns" the budget and that he had its support for tough measures.

The threat of rating agency downgrades might have been less of a concern than the possibility of a "debt trap", which might see interest costs take more and more out of a limited public purse and ruin the state’s ability to respond to crises or to demands to spend on big new policy initiatives.

But look towards the end of the frame of the medium-term budget, and just beyond it, and the case for fiscal consolidation now rather than later might be easier to understand. Just beyond the frame is the next general election in 2019, in the run-up to which the ruling party would presumably like some firepower to announce new spending plans.

It will also need to build up significant cash by the end of the medium-term timeline in 2017-18 because of large debt repayments looming. Loans taken out to finance the jump in budget deficits in the wake of the financial crisis will come due — domestic loan redemptions climb to R88bn in three years’ time, from R33bn now, adding to the government’s borrowing requirement.

More immediately, though, it may simply have been a dose of reality — a recognition of how poor the economy’s prospects are in the near future. Nene revised his growth forecast for this year down to 1.4%, from the 2.7% in the February budget, and he now expects tax revenue to fall just more than R10bn short in the current year.

But Wednesday’s budget was really about the next two years — although growth is expected to rise to more than 2%, forecasts have been revised down significantly there too, and the total revenue shortfall for the two years would have been a huge R51bn in the absence of any tax policy moves.

What Nene has done, then, is to stick to the deficit target and allocate the "pain" of doing that equally between cuts to the spending ceiling and "structural" tax changes that are not yet identified, but could include a wealth tax and whatever changes the Davis committee might recommend between now and February. A spending ceiling was imposed in 2012, which held real growth to about 1.8% a year, but that has been cut in a way meant to ensure that frontline service delivery is not affected and the poor are protected. Departments will have to cut nonessential spending on catering, consultants and the like; funding for vacant posts will be withdrawn; and transfers to public entities, especially those with cash of their own, will be cut.

These look a little like sleight-of-hand cuts, as some of that money wasn’t going to be spent anyway. But Treasury officials argue the cuts will force departments to make choices and will impose pain.

Tax and spending are two elements in a five-part fiscal package to "reinforce sustainability". Strengthening and lengthening the budget process itself is a third, and a freeze on government personnel numbers is a fourth. That is likely to be tough to implement, and possibly controversial, but even more so will be the final element — any financing for state-owned companies must be "deficit-neutral".

Wednesday’s speech reflected a firmer and more pragmatic line on state-owned companies. They will, it seems, need clearer business plans if they want money. And if they get any, it won’t be from tax revenue or government borrowing. It will have to be from the sale of "nonstrategic assets" and Nene indicated there is a potentially long list, with the government doing a comprehensive review to identify anything it does not have to own.

Alternatively, it could come from private participation — no ideological shift to privatisation, necessarily, rather a pragmatic response to constraints, with the government now willing to contemplate bringing in private investors in one form or another.

Wednesday’s budget more generally reflected a nuanced, if important shift in attitudes to the private sector, with more emphasis, for example, on the need for the government to cut its own consumption as part of creating an environment in which it would be more attractive for the private sector to invest (alongside the public sector), helping to drive the "investment-led growth" that the National Development Plan aims for.

But will it all work? One risk is the economy, and while forecasts have been revised down, they may still be too optimistic, raising the question whether Nene has cut enough. And while Nene’s colleagues may have signed up, the proof of whether they have really taken fiscal consolidation on board will be once the departments have to make those cuts. A particular problem will be in the provinces — Nene has implored them to cut in ways that will preserve frontline service delivery and cut nonessentials, but they are entitled to make their own decisions and may choose catering and consultants over textbooks or toilets.

A key risk to the framework — as the Treasury emphasises — is the public sector wage bill. With unions demanding a 15% rise, budgeting for a 6.6% average annual increase in total compensation seems unrealistic, and as Nene has made it clear that any extra will have to be found through savings, departments and provinces may resort to cutting essential services to fund salaries — or to cutting jobs. Whether they would have the political support to do that, whatever Nene says, is a question that needs answering.

So is whether he will have the support to stand up to calls for funding for state-owned ventures such as PetroSA’s aspiration to buy Engen, or vanity megaprojects such as the new nuclear build, which it seemed earlier had bypassed budgets to be agreed upon by President Jacob Zuma and Russian President Vladimir Putin. Cabinet support or not, one of the biggest risks to the budget framework might well be "number one" himself.

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