Fiscal debt puzzle

THE question on everybody's lips before Tuesday's Medium-Term Budget Policy Statement (MTBPS) was whether it would represent a lurch to the left. Fears that the leftists were taking over intensified as it seemed that Finance Minister Pravin Gordhan's predecessor, Planning Minister Trevor Manuel, was being sidelined.

But Gordhan proved adept at playing to both sides of the gallery. He promised relief from the recession and jobs, but at the same time committed himself to cutting the fiscal deficit.

The key to whether there's been a lurch to the left lies in the fiscal deficit figures. It doesn't depend on the rhetoric, which in the first chapter of the MTBPS document was at times fairly leftist. No, it lies in the hard deficit numbers.

What story does Gordhan's deficit numbers tell? Unfortunately, the answer isn't straightforward. It seems possible that the minister has relied on smoke and mirrors. Some would say that he had no choice - it was the only way to conjure himself out of a tight spot.

The deficit is the shortfall between spending and revenue. It is usually expressed as a percentage of gross domestic product (GDP), because that gives the public an indication of how much of the national wealth is used up in net new government borrowing.

Global woes won't ease the pain

If the deficit grows too much, or stays too high for too long, the country could find itself in a situation where it's borrowing simply to service its debts. This obviously leaves less and less money for other kinds of spending (such as social and capital) if the situation isn't brought under control. That was the situation Manuel found himself in when he unveiled the Growth, Employment and Redistribution (Gear) strategy in 1996.

Now Gordhan finds himself with a deficit of 7.6% of GDP in the present fiscal year - against a budgeted figure of 3.8% and a previous year's deficit of only 1%. Of course, this should be seen against the backdrop of a global financial crisis, in which major economies are running deficits of 12% of GDP.

But the last time SA's deficit was at this level was in 1993.

Being in a fiscal debt trap isn't any better if other countries are in the same position. The pain remains the same. To avert that pain, Gordhan has proposed to cut the deficit to 6.2% of GDP in 2010/11, 5% of GDP in 2011/12 and 4.2% of GDP in 2012/13.

On the face of it, the response should be hooray! But a few quick calculations on the components of the deficit for the next fiscal year raise some crucial questions.

Trouble is, Gordhan will have a major battle on his hands to meet his revenue targets for the next fiscal year. He is budgeting for revenue of R743.5bn in 2010/11 - an eye-popping 13% increase on the 2009/10 estimate. Even if one adjusts for transfers to the SA Customs Union, it remains a whopping 11.8% hike.

Inflation on a white charger?

Now, this doesn't tally at all with Gordhan's own economic growth projections. He is predicting a very weak growth rate of 1.5% for 2010. For the fiscal year 2010/11, his growth projection is 2%.

Perhaps inflation can come to the rescue, as it sometimes does for government revenue. Gordhan estimates inflation at an average of 6.4% for the next fiscal year. Inflation plus real growth yields a nominal GDP growth rate of 8.4%.

The nominal economic growth rate is a good proxy - in the absence of fancy models - of the revenue growth rate. And this still falls below Gordhan's estimate of revenue growth of 12% to 13%.

The difference may not be massive, but at this point anything more than the budgeted 6.2% of GDP will be too high for the next fiscal year.

As it is, state debt cost is projected to rise at an average annual rate of 18% between 2009/10 and 2012/13 - far and away the biggest increase in spending. Even if things work out as Gordhan predicts, interest costs will already be crowding out a lot of other state spending.

The MTBPS picture is somewhat puzzling, but there isn't enough space to go into all of it. Still, one question that arises is whether Gordhan's assumption of a 2% economic growth rate for the 2010/11 fiscal year isn't too low.

On the one hand, Gordhan is being super-realistic about growth; on the other, he is being super-unrealistic about revenue. You can't have both. Hopefully, his growth forecasts will prove to be too low.

- Fin24.com