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Johann Els Senior Economist OMIGSA

The 2008 Budget: Facing the biggest challenges in years Johann Els Senior Economist OMIGSA Background to the budget Global environment Much more uncertain/volatile environment Worries about USA recession Will rest of the world decouple from USA? Will Fed’s interest rate cuts work?

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Johann Els Senior Economist OMIGSA

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  1. The 2008 Budget: Facing the biggest challenges in years Johann Els Senior Economist OMIGSA JE\Budget preview to press Feb 2007

  2. Background to the budget Global environment • Much more uncertain/volatile environment • Worries about USA recession • Will rest of the world decouple from USA? • Will Fed’s interest rate cuts work? • Panic about global credit crisis • Inflation also still a problem JE\Budget preview to press Feb 2007

  3. Background to the budgetLocal economy • Start of 2008 marked by heightened pessimism • Worries about global situation • Sharply slower consumer spending growth recently • Worries about electricity problems and impact on economy • Still big current account deficit • Policy uncertainty • High inflation • Rand reflecting these worries JE\Budget preview to press Feb 2007

  4. Background to the budgetRand exchange rate reflecting global & local concerns Foreign currency per USD, Indexed Jan 2006 = 100 130 130 120 120 SOUTH AFRICA 110 110 Weaker ICELAND MEXICO 100 100 TURKEY NEW ZEALAND CANADA 90 90 Stronger INDIA HUNGARY EURO 80 80 AUSTRALIA BRAZIL CZECH REP 70 70 2006 2007 2008 JE\Budget preview to press Feb 2007

  5. Underlying picture of strong growth and low inflation seems intact Or is it? Shorter term pressures have shown themselves CPIX inflation (annual, 3-year ma) GDP growth (annual, 3-year ma) 10.0 25 7.5 20 5.0 15 2.5 10 0.0 5 -2.5 Y-o-y of quarterly data Y-o-y of monthly data -5.0 0 80 85 90 95 00 05 10 80 85 90 95 00 05 10 Background to the budgetSlower growth, higher inflation, big current account deficit JE\Budget preview to press Feb 2007

  6. Much weaker local spending growth; big current account deficit 20 50 Retail sales growth Current account balance as % of GDP Car sales growth 40 10 20 0 0 -10 -20 -20 -30 70 75 80 85 90 95 00 05 10 00 02 04 06 08 Background to the budgetSlower growth, higher inflation, big current account deficit JE\Budget preview to press Feb 2007

  7. Iceland Bulgaria Romania Serbia Greece New Zealand Croatia Turkey South Africa Fear that SA’s deficit will move higher still… United States Hungary Australia Poland Czech Republic India Mexico South Korea Brazil Canada Indonesia Current account balances as % of GDP Botswana Chile Thailand Russia China Malaysia Saudi Arabia Singapore -20.0 -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 20.0 25.0 30.0 Background to the budgetSA’s current account deficit in context JE\Budget preview to press Feb 2007

  8. Big 4 commodity export prices Exports ($) 6750 340 250 5000 4000 180 150 3250 110 2500 2000 80 95 97 99 01 03 05 07 Background to the budgetBut exports should benefit from commodity prices JE\Budget preview to press Feb 2007

  9. Growth forecasts revised lower, inflation forecasts higher GDP CPIX (avg) 9 7 Actual GDP growth Actual CPIX inflation 8 2009 forecasts 6 2008 forecasts 5 6 4 2009 forecasts 4 2008 forecasts 3 2 2 04 06 08 04 06 08 Background to the budgetSlower growth, higher inflation, big current account deficit JE\Budget preview to press Feb 2007

  10. GDP growth HCE growth CPIX inflation • 4.5% 4.2% 5.4% • 4.8% 4.5% 4.6% • ERU forecast: • 2008 3.8 3.8 7.1 • 2009 4.0 4.0 5.0 Treasury’s macro assumptions: MTEF October 2007Likely to be revised lower – DG: “revisions not dramatic” Impact of electricity problems could reduce 2008 GDP growth by as much as ½% – 1%. Thus growth forecasts reduced from 4% - 4.5% to 3.5% - 4%. JE\Budget preview to press Feb 2007

  11. Sound fiscal stance expected to continueIn light of market turmoil and despite pressures • Reason for budget surplus (quote from Oct 2007 MTEF): • “ In the context of current macroeconomic pressures and extraordinary buoyancy in revenue, it is recognised that government should contribute positively to national savings. By not spending the full value of buoyant tax revenues, government helps to limit current account and inflationary pressures, and takes some pressure off domestic interest rates, contributing to the sustainability of economic growth.” • This was reconfirmed in president Mbeki’s State of the Nation Address: • “At the macro-economic level, we will continue to maintain a fiscal posture that supports continued economic growth and development and reducing our external vulnerability.” JE\Budget preview to press Feb 2007

  12. Budget balance, % of GDP (actual & Treasury targets) +2 +2 OMIGSA est (+0.9%) 0 0 -2 -2 Oct ’07 MTEF (+0.5%) (Feb budget was +0.6%) -4 -4 -6 -6 -8 -8 85 87 89 91 93 95 97 99 01 03 05 07 09 11 Background to the budgetWindfall revenues “saved” in form of surpluses JE\Budget preview to press Feb 2007

  13. Budget balance, % of GDP 2 2 Actual deficit outcome 0 0 -2 -2 Better than budgeted balances (Rbn): 04/05 -R21.3bn 05/06 -R43.0bn 06/07 -R32.6bn 07/08 -R7.0bn -4 -4 Deficit target at time of budget speech -6 -6 96 98 00 02 04 06 08 10 Background to the budgetActual budget deficits vs initial budgeted target JE\Budget preview to press Feb 2007

  14. Main focus areas: Maintain macro-economic stability: Do not repeat 2002 & 2006 ‘errors’ of too big individual tax cuts Continue with sound fiscal policies (including budget surplus) – especially now with financial market turmoil & big current account deficit Revenue under pressure over next year or so But budget must still be growth friendly: Infrastructure spending plans already laid out Some extra spending (social & justice clusters) Tax cuts – only fiscal drag relief for individuals; what about companies? Electricity Eskom’s recapitalisation; incentives for consumers to switch to solar power etc… Budget 2008/09 challenge: How to contribute to macro stability in the face of all the challenges JE\Budget preview to press Feb 2007

  15. Widening spread between Eskom and government debt reflecting concern about Eskom’s financing requirement Basis point spread (%) between ES33 and the R209 RSA government bond 0.8 0.7 0.6 0.5 0.4 Jul-07 Apr-07 Oct-07 Jun-07 Jan-08 Mar-07 Aug-07 Sep-07 Dec-07 Nov-07 May-07 JE\Budget preview to press Feb 2007

  16. +R16.1bn extra revenue Progression of 2007/2008 budget numbers Original budgetOMIGSA est Rbn % Ch Rbn % Ch SPENDING 533.9 13.5 543.0 15.5 REVENUE 544.6 14.5 560.7 16.3 Balance Rbn +10.7 +17.7 % OF GDP +0.6 +0.9 JE\Budget preview to press Feb 2007

  17. WeightBudgeted Apr - Dec Increase y-o-y % ch Ind income tax 28.711.2 20.1 Co’s 25.6 16.2 22.1 STC 2.9 2.8 21.1 VAT 28.5 15.3 12.1 Excise 3.5 9.110.5 Customs 5.0 14.4 12.0 Fuel Levy 4.4 9.512.1 Extra (likely final less orig budget) (Rbn) 13.4 5.5 2.2 -6.0 Looking back at 2007/08: Revenue surprises strongly on the upside again JE\Budget preview to press Feb 2007

  18. Actual revenue growth vs budget projectionsSharply reduced extra collection this year % growth 20 20 Overrun% of RbnBudg 97/98 1.4 0.9 98/99 7.4 4.2 99/00 6.5 3.4 00/01 5.2 2.5 01/02 15.0 6.4 02/03 13.2 5.0 03/04 -2.0 -0.7 04/05 21.0 6.4 05/06 41.8 11.3 06/07 34.8 7.8 07/08 16.1 3.0 Actual outcome 18 18 16 16 +R16bn +R42bn 14 14 +R35bn +R21bn 12 12 10 10 8 8 Original budgeted revenue growth 6 6 97 99 01 03 05 07 JE\Budget preview to press Feb 2007

  19. 2008/09 BudgetProjections on unchanged tax base Rbn % ch Expenditure 599.9 10.6% (MTEF numbers) Revenue 620.1 10.6% (unchanged tax base) Budget balance +20.2 = +0.9% of GDP BUT: Balance target +16.1 = +0.7% of GDP Difference between two balance figures = R4.1bn + R3bn in ‘normal’ tax increases ± R7bn available… JE\Budget preview to press Feb 2007

  20. What are the options? • ±R7bn available: what are the options? • Could potentially add to R7bn by budgeting for lower surplus (or balanced position or even deficit) • e.g. Balance from +0.7% to 0.0%  extra R16bn • Thus potential give-away-amount could swell to ±R23bn… • Budget for higher surplus – possible, but unlikely given pressures this year • e.g. Balance from +0.7% to +1.0%  cost R6bn • THUS R7bn to R23bn for: • Tax cuts • Extra spending • Likely: combination of tax cuts and higher spending JE\Budget preview to press Feb 2007

  21. Revenue sources2007/08 vs 2000/01 45% 00/01 07/08 40% 35% 30% 25% 20% 15% 10% 5% 0% Fuel Other Individuals Co's Vat C&E JE\Budget preview to press Feb 2007

  22. Rbn Individual tax cut Rbn 97/98 2.8 98/99 3.7 99/00 4.9 00/01 9.9 01/02 8.3 02/03 14.9 03/04 13.3 04/05 4.0 05/06 6.8 06/06 13.5 07/08 8.4 08/09 4.0 15.0 Individual inc tax revenue overrun 12.5 Individual income tax cut 10.0 7.5 5.0 Less likely to be given away this year? 2.5 0.0 -2.5 97 99 01 03 05 07 09 Individual income tax cut vs revenue overrun JE\Budget preview to press Feb 2007

  23. 65 60 60 55 55 50 50 45 45 42 40 40 35 30 1977 1980 1981 1996 2001 2003 Individual income tax: top marginal rate JE\Budget preview to press Feb 2007

  24. 55 50 50 48 45 40 40 35 35 30 29 30 25 20 1990 1991 1993 1994 2000 2005 Company tax rates STC down from 12.5% to 10% from 1 Oct 2007;to be replaced with a dividend withholding tax from 2008 JE\Budget preview to press Feb 2007

  25. Principles in decision over ‘what to do’ • Maintain conservative approach to fiscal policy • Work with conservative revenue forecasts • Budget for surplus in 08/09 • Beware of stimulating consumer • Personal tax cuts only aimed at offsetting fiscal drag? • Functional capacity of economy & social delivery remains key focus: • Social support (social security payments) • Additional spending on key areas (protection & justice, • Encourage savings, retirement provision: • More detail on social security system • A bold move to support growth?: • Announcement of planned further corporate tax rate cuts? JE\Budget preview to press Feb 2007

  26. Tax changesOMIGSA speculation… • R4bn (– R5bn) on individual income tax relief (fiscal drag offset) • Some VAT relief on essential foods? • Other… company tax rate What it will cost to change VAT (highly unlikely) or company tax rate: 2007/2008 Rbn current rate 1% cost (Rbn) MTEF budget ERU est Vat 147 150 14 10.7 Co's 140 144 29 5.0 JE\Budget preview to press Feb 2007

  27. Tax changesOMIGSA speculation… What do we prefer? • Individuals: no big relief, only for fiscal drag • Company tax relief JE\Budget preview to press Feb 2007

  28. Wages 35.4% 39.8% Other current 34.5% 47.2% 3% Capital 7.6% 19.8% Interest 9.8% 00/01 07/08 Expenditure components JE\Budget preview to press Feb 2007

  29. as % of total expenditure Interest payments Wage bill 22 41 20 40 18 39 16 38 14 12 37 10 36 8 35 6 93 97 01 05 09 93 97 01 05 09 Substantial improvement in 2 big components… JE\Budget preview to press Feb 2007

  30. Other spending benefiting from lower spending on wages & interest component weight Expenditure estimate R599.9bn Wage bill (12.4% increase) 36.0% 215.7 Interest payments 8.5% 51.2 Other 55.5% 333.0 =11.9% ch Spending increases: (MTEF data) Interest & wage +9.0% (10.3%) Non-interest, non-wage +11.9% (19.9%) Capital spending +15.5% (32.1%) Current (i.e. non-capital) +10.2% (14.2%) JE\Budget preview to press Feb 2007

  31. Infrastructure spending plansbig numbers, but growth slowing Growth in TOTAL 32.9% 15.5% 8.9% 7.3% Total of R438bn over this period (from R410bn previously) Total of R611bn over 07/08 to 10/11 period MTEF Oct 2007 numbers – likely to be lifted significantly going forward – mainly from Eskom’s side JE\Budget preview to press Feb 2007

  32. In summaryIssues in this budget • Individuals vs companies • No big individual tax cuts foreseen • But at least some fiscal drag relief for individuals • Company tax rate cut? • Cuts in company taxes • Normal sin taxes and fuel levy hikes • No VAT change JE\Budget preview to press Feb 2007

  33. In summaryIssues in this budget • Expansion on announcements from State of the Nation Address • Industrial policy action plan • APEX priorities • Eskom recapitalisation • Likely combination of cash, loans, debt guarantees • Cash likely to be classified as “extraordinary payments” and thus will not impact on budget balance • Will impact on funding, though • More detail on social security system • Exchange controls? • Extra social spending • Child grants extended • Male pension age lowered from 65 to 60 JE\Budget preview to press Feb 2007

  34. In summaryIssues in this budget • What will be big surprises? • BIG company tax relief • BIG exchange control relaxation • Large budget deficit JE\Budget preview to press Feb 2007

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