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COMMENTARY ON THE 2004 BUDGET 

A: INTRODUCTION 

The purpose of this commentary is to look at the economic impact of the budget as well as the possible impact on the exchange rate. 

The question that can be asked is whether the budget is stimulatory or restrictive. If it is stimulatory it in the short-run increases economic growth and if it is restrictive it limits economic growth. 

The budget is also being used more and more as an instrument to redistribute income and this holds in consequences for the economy. 

The discussion starts by looking at the economic assumptions underlying the budget and then looks at the budget itself. The possible impact of the redistribution aspect of the budget as well as the impact on the exchange rate as well as monetary policy is also evaluated after which concluding remarks follow. 

B: ECONOMIC ASSUMPTIONS AND BUDGET DEFICITS 

The economic assumptions underlying the budget are given in the table below.

Over the last couple of years a tendency has arisen to give a too optimistic forecast on economic growth and actual growth was much less than was assumed in the budget. 

In the graph below actual growth is contrasted with assumed growth as given in the budgets from 1999 to 2004. Where assumptions in the early years were still in line with actual realized growth the assumptions in later years were too optimistic.

From the 2002 budget growth assumptions were given that is out of line with actual growth. The growth expected of 2.9% for the current year is in line with forecasts made by private sector economists, but the growth of 3.6% for next year and 4% in 2006 is too optimistic. 

Of importance for the rand is the deterioration in the current account of the balance of payments from an estimated deficit of 0.8% in 2003 to 1.3% in 2004. If this deterioration was to happen it would be easily financed. The risk however is that the deficit will be much larger, which could be a problem financing it. 

The realization of economic growth weaker than what is assumed in the budget can ultimately influence foreign investors negatively as it may appear that the economy is in a low-growth trap. This situation is reminiscent of the situation of Mexico in the nineties when Mexico as is the case of South Africa today established macro-economic stabilization. When economic growth did not accelerate foreign investors withdrew their funds. This was one of the factors causing the Mexican crisis. 

The implication of realized growth being less than the assumed growth is larger budget deficits than assumed. The graph below shows the assumed as well as the realized budget deficits.

The actual budget deficits turned out to be much larger than assumed because actual economic growth came in much less than assumed. Where the assumption in the 2002 budget for the next fiscal year (year 2005) was for a budget deficit of 1.5% of GDP, this has now been changed to 3.1%. The larger budget deficits flows from the fact that realized economic growth turned out to be less than what was assumed. 

The larger budget deficits are cyclical in nature and have to do with the stabilization role that fiscal policy plays during times of a downturn in the economy to ameliorate the impact of the downturn. What is not clear however is that the budget deficits for 2006 and 2007 do not return to the deficits of 2002 to 2004 and this may indicate a more structural expansionist fiscal policy to stimulate economic growth. Should actual growth in later years be in line with expected growth the budget deficits would have been lower than indicated by the fiscus. 

C: THE IMPACT OF THE BUDGET 

The question with any state budget is whether the budget will add or subtract from economic growth. Spending in the economy over the last year was stimulated by a sharp decline in interest rates as well as a stronger rand and a fiscal stimulus could have caused spending growth to become unsustainable. The budget adds marginally to growth in spending. In the table below the tax proposals of the budget is put in context. 

The net impact of the budget is tax relief of R2.3 billion, which at about 0.2% of GDP is very small, making for a marginal impact on the economy. 

Because tax relief for individuals has taken place for a considerable time there is great possibility that the tax cuts could be seen as permanent leading to individuals saving a larger part of the tax cut. Redistribution of income through the budget however favours spending over investment. 

As in previous years the budget is used as a tool to redistribute income and 60% of the tax relief accrues to persons earning R150 000 or less per year. The redistribution of income to people that has a larger propensity to consume than high income earners places the already low personal savings rate under further downward pressure. 

It can therefore be expected that the greatest part of the tax relief will be spent on consumer goods instead of investment goods. This will boost economic growth in the short-run, but will come at the cost of lower sustainable economic growth in the long-run. 

The impact however is very small. 

The moderately stimulatory budget should keep the rand under mild upward pressure. It may also keep the Monetary Policy Committee (MPC) of the SARB not to lower rates when they meet on February 26 and 27. A lowering of rates by the MPC could result in too much stimulus, which may make it difficult to finance the resulting deficit on the balance of payments. 

D: CONCLUDING REMARKS 

The budget is mildly stimulatory and may convince the MPC not to lower rates at their meeting on the 26^th and 27^th of February. Inflation is forecasted to stay in the target bands, making for a more stable monetary policy. 

The increasing use of the budget as a tool to affect income redistribution encourages consumption over investment and compromises long-run economic growth in favour of short-term stimulus. Income redistribution takes place easier in an environment of rapid economic growth and care should be taken not to use the budget for this purpose. 

The impact on the rand is possibly positive over the short-run, but negative over the long-run when it proves difficult to finance the larger deficits on the current account flowing from the stimulus. 

From the figures at least it appears that there is a shift to larger budget deficits to stimulate economic growth and that fiscal policy could in future become even more activist. 

Updated on 19 February 2004. 

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