South African Minister of Finance Trevor Manuel

Following the outcome of the African National Congress’s (ANC’s) conference in Polkwane, Limpopo, in December last year, it might have been thought that the 2008 National Budget as presented by Finance Minister Trevor Manuel in February would throw up a number of surprises and see a deviation from the prudent stance he has taken in the past.

New ANC president Jacob Zuma’s populist and left-leaning stance was thought in some quarters to signal a change in policy that could negatively affect foreign direct investment into the country. Though not as high as it could have been, investment into South Africa from abroad has continued to grow over the period of Manuel’s tenure. The private sector would not like to see major changes that could unsettle their activities in Africa’s largest economy.

This political angle, however, is not a matter that would be reflected in or resolved in this budget. Many of the decisions, designed to manage the worldwide economic downturn and anxieties at home, had already been taken well before the changing of the guard of the ruling party and the policy decisions taken at its year-end conference.

Changing of the guard
While some analysts still fear a toppling to the left if Zuma becomes president of the country after next years elections, recent evidence – particularly Zuma’s wooing of big business and his recently stated position on South African labour law – suggests that it is by no means certain that he is the champion of the left that he was made out to be in the run up to Polokwane. There is a discernable gap opening up between him and his allies in the Congress of South African Trade Unions and the South African Communist Party.

This view is reinforced by what Manuel himself had to say about the relationship between the content of the budget and party policy at a media briefing after the presentation of the budget: that there is no contradiction between the policies decided on in Polokwane and the 2008 budget. For the Finance Minister, the budget is a statement of confidence – and he wants potential investors to see it this way.

The ANC too has confirmed this stance, indicating that the budget is in line with resolutions on economic growth and job creation taken by the party in Polokwane. South African Chamber of Commerce and Industry president Alwyn Louw is of the opinion that Manuel’s latest budget does not deviate from the medium-term budget policy announced in 2007, rather showing an adherence to a steady economic path.

The economy, stupid
At home, on the economic front, the country faces one of its biggest crises in recent years – rolling power outages, euphemistically termed ‘load shedding’ by state-owned electricity supplier Eskom – has left industry in the lurch and is taking its toll on the economy. GDP growth forecasts for this year have already been downgraded in the face of power shortages for which no one has yet come up with an short-term solution, other than cutting back on usage.

On top of this the global economic climate is looking decidedly sombre and the slowest growth in at least seven years is forecast for 2008. The subprime mortgage crisis in the United States and the resultant global credit crunch have made investors increasingly risk-averse, while an oil price that will no doubt settle somewhere above US$100 a barrel in the not too distant future has raised costs everywhere.

Locally, there is also the fact that, as Idasa points out, the South African economy ‘faces lower than expected growth coupled with higher than expected inflation’. Interest rate increases, designed to ward off further increases in inflation, have led to a downturn in domestic spending – a not insignificant fact for an economy that has had much of its growth come on the back of exactly this spending.

While reception of the budget by politicians has on the whole been positive, a number of economists have expressed surprise at the fact that the government is willing to run a budget surplus under current global economic conditions, suggesting that South Africa should be running a moderate deficit as world economies are slowing; but as ETM economist George Glynos pointed out, Manuel moved to allay fear among foreign investors that the economy was in trouble.

As it stands, investors stand to benefit from the 2008 budget: tax on businesses has been reduced by 1% to 28%, bringing it in line with international practice (and the same as the UK), and exchange controls have been removed for institutional investors.

Tax breaks for large and small
Tax on corporations has been on the increase since the turn of the century. However, with the revenue provided by these taxes (and improved methods of tax collection), the treasury is now reducing the rate of corporate tax and giving R5-billion back to businesses. The aim is to reduce the cost of capital and thus of new investments, thereby increasing investment by the private sector and stimulating the economy’s supply side. Manuel indicated that, with higher growth over the past years, a broader tax base and improved compliance by businesses, corporate tax could be further reduced in future.

Small and medium-sized enterprises in high-tech sectors and junior mining companies also stand to benefit with government support for greater access to equity finance. Venture capital investments of non-mining companies will receive a tax incentive in the form of a 30% up-front deduction, while junior mining companies get a 50% deduction for investments.

Institutional investors and exchange controls
South Africa first began to see a gradual liberation of exchange control limits on foreign investment by institutional investors in 1996. This allowed a diversification of foreign investment. The current budget sees more withdrawing of these limits on investment exchange-control flows.

Institutional investors will no longer have to obtain approval from the South African Reserve Bank (SARB) for offshore investments – instead SARB’s exchange control division will be replaced by a new financial surveillance department and foreign investment will be overseen by prudential investment guidelines with monitoring of cross-border flows. A system of quarterly reporting and monitoring of foreign exposures will be put in place by SARB. The logic here is that the country is far less vulnerable to external shocks than in the past and there is no longer any need to protect the currency or reserves. Some analysts have noted that the move was a confident one given current turmoil on the global markets – in his presentation Manuel called this the ‘biggest shift to date’ for currency policy.

On the day of Manuel’s budget speech, the rand dived 3% to a five-year low against the US dollar. This was the time in a number of years that the currency had reacted to the budget and is perhaps more a sign of global turmoil than domestic worries. The currency has been trading in a narrow and steady, although relatively weaker, range since then. Rand Merchant Bank expects that it will continue to fluctuate between R7.56 and R7.97 for the year. 

This anticipation of large capital outflows, however, is but a temporary downside to the coming end of exchange controls: as fund managers increase their offshore exposure, more money is leaving the country and the currency and the economy are bound to be weaker for a while. While the weaker rand could result in an increase in inflation and thus put further interest rate hikes back into the picture, it bodes wells for export-focused local manufacturing and production.

Keeping the lights on
Forecasts are that capital expenditure for infrastructure expansion by Eskom will amount to R342.9-billion between this financial year and 2012/2013 – nearly three quarters of it for building more power stations to increase energy generation capacity. The government has indicated that it will loan Eskom R60-billion to cover medium-term cash flow requirements over the next five years so that electricity-supply constraints can be eased.

The 2008 budget proposes a 2c/kWh tax on the sale of electricity generated from non-renewable resources, complemented by incentives to encourage companies to act in an environmentally responsible way. This promotion of the efficient use of energy should generate R2-billion this financial year and R4-billion per year thereafter. It was indicated that current tax incentives encouraging the development and exploitation of renewable energy could be enhanced.

The loan may not, however, be enough to maintain the electricity supplier’s credit rating, especially considering the lack of detail on the package, and further funding will need to come from Eskom and its customers – in the form of a 14.2% increase in prices from April, followed by further tariffs hikes of at least 20% per year for the next five years, generating an extra R70-billion for the state-owned company.