US embassy cable - 04PRETORIA4879

UNCLAS SECTION 01 OF 03 PRETORIA 004879 
 
SIPDIS 
 
SENSITIVE BUT UNCLASSIFIED 
 
DEPT FOR AF/S/JDIFFILY; AF/EPS; EB/IFD/OMA 
USDOC FOR 4510/ITA/MAC/AME/OA/DIEMOND 
TREASURY FOR OAISA/BARBER/WALKER/JEWELL 
USTR FOR COLEMAN 
LONDON FOR GURNEY; PARIS FOR NEARY 
 
E.O. 12958: N/A 
TAGS: ECON, EINV, EFIN, ETRD, SF 
SUBJECT:  MID TERM BUDGET POLICY STATEMENT 
 
 
SUMMARY 
------- 
1. (U) Finance Minister Trevor Manuel presented the 
 Mid Term Budget Policy Statement (MTBPS), supporting 
 the South African government's three-year budgeting 
 plans under the Mid Term Expenditure Framework.  The 
 MTBPS updates economic growth, revenue and 
 expenditure forecasts and suggests potential policy 
 changes that support government's key priorities. 
 Highlights of Manuel's presentation include:  (1) 
 fiscal policies remaining slightly expansionary with 
 an increased budget deficit expected in the next 
 fiscal year; (2) no substantial tax changes; (3) an 
 additional R50 billion ($8 billion using 6.2 rands 
 per dollar) aimed at poverty alleviation, 
 infrastructure, and increased wages for teachers and 
 police; and (4) relaxation of foreign exchange 
 controls on South African corporations.  Compared to 
 last February's formal budget submission to 
 Parliament, the SAG is now forecasting higher growth 
 for 2005 and 2006.  While macroeconomic indicators 
 are good, the government still faces challenges in 
 reducing unemployment and controlling growing 
 expenditures on social welfare grants. 
 
INTRODUCTION 
------------ 
 
2. (U) Every October, the Finance Minister presents 
 the Mid Term Expenditure Framework (MTEF) to 
 Parliament which details updated budgetary plans for 
 the next three fiscal years.  On October 26, Trevor 
 Manuel summarized proposed policy changes and updated 
 economic, expenditure and revenue estimates in his 
 Mid Term Budget Policy Statement (MTBPS), which 
 outlines the government's MTEF.  The MTBPS provides 
 an opportunity for a mid-year adjustment for policies 
 that would support key government priorities and 
 forecasts that determine how well macroeconomic 
 targets are met. 
 
MACROECONOMIC FUNDAMENTALS ON TRACK 
----------------------------------- 
 
3. (U) The National Treasury revised GDP growth 
 forecasts upward.  It now expects growth to be 3.9, 
 3.7, and 4.2 percent for 2005, 2006, and 2007 
 respectively, compared to 2.9 percent expected for 
 2004.  (Note: Growth forecasts are given for calendar 
 years instead of fiscal years. Endnote.)  The 
 Treasury expects the targeted inflation rate (i.e., 
 consumer prices excluding mortgage costs) to remain 
 within the 3-6 percent range throughout the MTEF 
 period at roughly 5 percent, slightly higher than 
 expected for 2004.  In 2004, the current account 
 deficit should widen, reaching 2.2 percent of GDP as 
 compared to 0.8 percent in 2003, but be easily 
 financed from capital inflows.  The current account 
 deficit rises over the MTEF period gradually, 
 reaching 2.8 percent in 2007.  The country's balance 
 of payments position is strong, allowing the South 
 African Reserve Bank to steadily increase foreign 
 reserves. 
 
4. (U) Domestic investment has grown over the past 
two years, with real fixed capital formation 
 increasing by 6.1 and 8.4 percent compared with real 
 GDP growth of 3.6 and 1.9 in 2002 and 2003.  However, 
 the government wants to dramatically increase gross 
 fixed capital formation over the next three years to 
 grow the economy at 6 percent, the figure believed to 
 be necessary to make real progress in reducing the 
 country's very high unemployment.  Gross fixed 
 capital formation currently is 16 percent of GDP. 
 The government's goal is increase this to 25 percent 
 of GDP by 2014.  Low inflation and interest rates 
 should help this effort, as should the government's 
 intention to undertake a massive spending program to 
 invest in the country's infrastructure through public- 
 private partnerships. 
 
REVENUE OUTLOOK STRONG 
---------------------- 
 
5. (U) For FY2004, tax revenue is expected to be R1.9 
 billion higher than estimated last February, largely 
 because of higher than expected collections in value 
 added and personal tax revenues.  Corporate taxes 
 should be R6.2 billion less than budgeted, as the 
 strong rand has hurt corporate profits.  In FY2004, 
 revenues as a percent of GDP should be 24.5 percent, 
 rising to 25.1 percent by FY2007.  Over the next two 
 fiscal years, revenues are expected to increase by 10 
 percent and expenditures by 9 percent, which should 
 cause the deficit gradually to improve.  According to 
 the National Treasury, the budget deficit as a 
 percentage of GDP should be 3.2 percent in FY2004, 
 3.5 percent in FY2005, 3.2 percent in FY2006, and 2.7 
 percent by FY2007.  Manuel announced no new tax 
 policies, but did tag the mining sector for a full 
 review. 
 
EXTRA SPENDING NEEDED THIS YEAR 
------------------------------- 
 
6. (U) The government will spend an extra R50 billion 
 ($8 billion) on poverty alleviation, infrastructure 
 improvements, and increased wages of teachers and 
 police.  Out of the R50 billion, 20.8 ($3.4) billion 
 will go to cover growing expenditures related to 
 social welfare grants, especially in the categories 
 of child support and disability.  Two million people 
 joined the list of grant beneficiaries between April 
 and September alone, pushing the total number of 
 beneficiaries to nine million - or one out of every 
 five South Africans.  Currently, the provinces 
 administer three types of grants are given: (1) child 
 grants (also including foster care) for children up 
 to 10 (this will be extended to children aged 13 in 
 2005); (2) disability grants (here, definitions have 
 been unclear and this is a source of concern); and 
 (3) grants for the elderly. 
 
7. (U) Beginning in March 2006, a new national 
 welfare grant agency will take over the 
 administration of welfare funds from provincial 
 government.  In the meantime, welfare funds will be 
 sourced from conditional grants (grants paid by the 
 national government to provinces for prescribed 
 purposes) rather than from the equitable share of 
 revenue that the provinces get from the national 
 government.  The change means that overruns will now 
 be the responsibility of the national government, 
 even though the provinces will continue to distribute 
 the grants until the changeover in 2006.  Under the 
 current system, the provinces must fulfill their 
 obligations for paying out social welfare grants over 
 other forms of provincial expenditure.  In some 
 cases, this has meant that the provinces have had to 
 cut back on critical health and education 
 expenditures, or taken bank overdrafts, to pay out 
 growing numbers of social welfare grants. 
 
FOREIGN EXCHANGE CONTROLS RELAXED 
--------------------------------- 
 
8. (U) Minister Manuel also recommended that certain 
 foreign exchange controls be relaxed.  Current rules 
 limit direct foreign investment by South African 
 corporations to R2 billion per project in Africa and 
 R1 billion elsewhere, plus 20 percent of any excess 
 cost.  Manuel removed these limits and lifted 
 restrictions on the repatriation of foreign 
 dividends.  However, corporations will still be 
 required to apply for South African Reserve Bank 
 approval (one of the stipulations being that the 
 investment must be in the interest of South Africa). 
 To facilitate his move to allow secondary foreign 
 listings on the South African exchanges, Manuel will 
 also allow South Africans to invest in such shares. 
 Limits on other foreign investments by South African 
 pension funds, insurance companies, mutual funds 
 (unit trusts), and individuals remain in place, but 
 could be removed in future. 
 
COMMENT 
------- 
 
9. (SBU) The state of the economy outlined by the 
 National Treasury in its MTBPS is fairly strong.  The 
 National Treasury fully expects inflation to stay on 
 target in the near term.  It believes that falling 
 interest rates will encourage more investment and 
 that this should lead to an average economic growth 
 of 4 percent over the next three years.  As revenues 
 increase and social grant payments are brought under 
 control, the National Treasury expects the fiscal 
 deficit to increase to 3.5 percent next year, but 
 then decline.  The healthy state of the South African 
 economy has led several international credit agencies 
 to revise or review their credit ratings.  One 
 question mark on the horizon is whether strong global 
 economic growth stays on track and whether the rand 
 will grow even stronger.  Another question mark is 
 what would happen if growth in Europe (South Africa's 
 major trading partner), and China (which is fueling 
 world demand for commodities) slows, as this would 
 have unfavorable consequences on South Africa's 
 manufacturing and minerals exports, and thus growth. 
 Finally, the government knows that the increase in 
 social welfare grant payments is not sustainable over 
 the long term and it needs to get control of the 
 situation.  Right now, the trend line shows these 
 expenditures rising from 16.9 percent of all 
 government expenditures in FY2003 to 20 percent in 
 FY2007.  The government wants to reverse this trend 
 in social welfare grants by growing the economy 
 faster and putting people to work.  While the 
 government's forecasted growth of 4 percent growth 
 over the MTEF is a solid improvement over the last 
 three year period, it is still less than what the 
 government thinks it needs to make a significant dent 
 in unemployment, i.e., GDP growth on the order of 6 
 percent. 
 
FRAZER