Government should use its cash
More borrowing unnecessary
WHEN FORMER Finance Minister Trevor Manuel unveiled a budget deficit of 3,8% of gross domestic product in February this year, economists said the Budget was expansionary. Most thought Manuel was sailing fairly close to the wind, as a Budget deficit of 3% of GDP had come to be seen as the “safe” level. But now it’s clear South Africa will probably see a deficit of around 5% of GDP this fiscal year.
Of course, that 3% benchmark has been smashed to smithereens worldwide, with major economies such as the United States and Britain racking up double-digit deficits. Given the global backdrop, SA is still looking very healthy indeed. But that doesn’t mean we shouldn’t be careful. After all, different rules seem to apply to emerging markets.
The trouble for SA’s Budget is that the “golden era” of growth – which averaged 5% between 2004 and 2007 – is well and truly over. Manuel budgeted for a growth rate of 1,2% for this calendar year but most economists now expect the economy to shrink by around 1,5%. That’s a big swing, which has major implications for revenue.
Economic growth is the key to revenue and in the halcyon years Government racked up either tiny deficits – too small to matter – or small surpluses. SA Reserve Bank figures – which are calculated on a cash flow basis – show Government recorded a deficit of 0,1% in the fiscal year ended March 2006 and surpluses of 0,8% and 0,9% in 2007 and 2008.
GDP is the key to revenue, because it’s the sum total of all activity in the economy. All domestic spending – which leads to VAT collections in the case of retail – form part of GDP. Companies’ profits depend on economic activity and the corporate tax take in turn depends on corporate profitability. If the economy shrinks, it stands to reason revenue will also shrink. That then leads to a bigger shortfall between spending and revenue – that is, the Budget deficit.
The way Government makes up the shortfall between spending and revenue is through borrowing. But that isn’t the only borrowing Government does in a fiscal year. In lean years with no extra revenue around Government rolls over – refinances – borrowings from previous fiscal years that fall due in the current fiscal year. That means that, with a significant deficit, there’s much demand for extra finance from the capital market.
Manuel budgeted for total financing of R90bn this fiscal year – massively up from the low level of financing of R19,9bn it budgeted in the previous fiscal year, or the net repayment of debt of R15bn in the fiscal year before that.
But that’s just looking at Government, the provinces and other entities related to central Government. When the public sector as a whole is looked at, the picture changes even more dramatically, as Eskom and Transnet are in the midst of major borrowing programmes of their own. In the current fiscal year the public sector borrowing requirement (PSBR) is budgeted at more than double the previous fiscal year at around R186bn. That means a massive increase in demand for capital from the bond market.
That’s set to increase further, because Government’s revenue will fall short of projections. The question is: How big will new Finance Minister Pravin Gordhan’s headache be? From comments from Treasury officials reported in the media, not so big – only R8bn, which in the context of a borrowing requirement of R186bn is small change.
But it could be worse, as Gordhan may follow Manuel’s lead in being too optimistic about GDP until the very end. Still, the capital market has already factored in extra borrowing.
However, in the fiscal years ahead Government is going to battle to get its borrowing requirement down, as GDP growth won’t reach the levels of the golden era over the medium term. And the more Government borrows, the more interest it has to pay, leaving less money for social and infrastructure spending.
A major question that arises is why Gordhan, like Manuel before him, doesn’t use the R66bn in “sterilisation deposits” Government has at the Reserve Bank instead of borrowing more. That R66bn was raised because Government continued borrowing in fiscal years when it was in surplus and ended up with massive cash balances.
It continued borrowing in those years because it wanted to drain cash out of the money market, which was being flooded with rand as the Bank bought US dollars in exchange for rand to build up its foreign exchange reserves. But there’s no reason now to be worried about adding to the money supply and that cash is lying idle at SA’s central bank while the market – needlessly, because that cash is there – worries about extra borrowing.
How big will the headache be? Pravin Gordhan