For an Equitable Sharing of National Revenue Briefing to the Standing Committee on Finance on FFC’s Submission on the 2011 Medium Term Budget Policy Statement 1 November 2011 For an Equitable Sharing of National Revenue

FFC Submission on the 2011 MTBPS Background Submission: response to requests from Standing Committee on Finance for FFC to comment on the 2010 MTBPS In terms of Part 1 (3) {1} of the FFC Act (2003) as amended Provides for Commission to act as a consultative body and make recommendations to organs of state in all spheres on financial and fiscal matters And Section 4 (4c) of the Money Bills Amendment Procedure and Related Matters Act (MBAPRMA)(2009) Requires Committees of Parliament to consider the FFC’s recommendations when dealing with money bills and related matters FFC Submission on the 2011 MTBPS

Outline of the Submission FFC’s Submission on the 2011 MTBPS is divided into following sections: Macroeconomic Outlook and Fiscal Framework Medium Term Spending Priorities Concluding Remarks FFC Submission on the 2011 MTBPS

I. Macroeconomic Outlook and Fiscal Framework

FFC Submission on the 2011 MTBPS Background Little has changed over the last year in terms of the vulnerability of South African economy to interruptions in global recovery 2011 MTBPS: downward revision of 2011 GDP figure (as expected) Major trading partners’ slow recovery may impact sectoral composition of GDP Finance, real estate and business services, manufacturing and wholesale, retail, motor trade and accommodation – likely sectors to be affected FFC Submission on the 2011 MTBPS

Economic Growth and NGP SA will need a much higher economic growth than set out in NGP (7% annually) Closer to the range of 8-9% if 2011 MTBPS forecasts materialise Highly unlikely given the growth rates projected for EMEs over the same period GDP growth forecasts in 2011 MTBPS based on restrictive assumptions: Orderly resolution of EU debt crisis, avoidance of US recession and continued strong growth in EMEs (particularly China) Current climate uncertain, so more pessimistic GDP growth rates are possible – exerts even more pressure on job-creation goals of government FFC Submission on the 2011 MTBPS

Economic Outlook: Fiscal and Monetary Policies To date, fiscal and monetary policies coordinated and countercyclical – aimed at boosting recovery In 2009/10 tax year, fiscal deficit increased to -7.3% of GDP (worst budget deficit since 1961) Currently at -5.5% of GDP (more than -5.3% budgeted in February 2011) Expected to decrease further over the medium run as SA economy recovers Relatively strong fiscal position threatened by possibility of global economy experiencing a renewed downturn Result in lower government revenue and higher government borrowing Repo rate reduced five times in 2010 to 5.5% (current level) to boost consumption spending FFC Submission on the 2011 MTBPS

Economic Outlook: Inflation Downward pressure: lower demand Upward pressure: weaker Rand, food prices (rising commodity prices), wage costs (public sector wage demands) and energy prices Recent CPI figures indicate a rise from 4.1% in March 2011 to 4.2% in April 2011 This slight increase indicates that inflation is on the rise Coincides with upward revision of inflation forecasts by SARB Indicates a repo rate increase later this year and further increases in 2012 FFC Submission on the 2011 MTBPS

Economic Outlook: Exchange Rate Important tenet of NGP: drive the value of Rand down Render locally-produced goods more competitive and create jobs SARB: increased reserves and capital flow moderation Weaker Rand Rand depreciated slightly since the beginning of 2011 Slight slow-down in G7 countries, world demand expected to decrease together with demand for SA goods Globally, we are at the height of uncertainty – expect capital outflows and hence a depreciation of the Rand World inflation expected to rise, hence countries will increase their interest rates → capital outflow from SA However, weaker Rand benefits exports but may fuel inflation To obtain more benefits from a competitive currency, SA needs to improve productivity and contain domestic costs FFC Submission on the 2011 MTBPS

Economic Outlook: Savings and Investment NGP: savings and investment in SA below levels needed for sustained growth Savings To achieve growth of more than 4%, domestic savings rate has to be some 24% of GDP Currently at some 16% (compare to 40% in China) Even worse: current ratio of savings to disposable income of households is -0.3 Investment Modest pick-up in investment rate expected in 2011 (low capacity utilisation) FFC Submission on the 2011 MTBPS

Economic Outlook: Unemployment QLFS 2011Q1: unemployment increased across all race groups despite moderate economic growth (current figure: 25%) In terms of sectors: Agriculture, construction, transport and communications, as well as financial and business services all reported job losses between 2010Q1 and 2011Q1 Need to tackle structural impediments to job creation over the coming years: lack of appropriate skills and education, labour market legislation and conditions, poor attention to entrepreneurship and small business FFC Submission on the 2011 MTBPS

FFC Submission on the 2011 MTBPS Fiscal Consolidation Fiscal consolidation still important in SA context Government debt set to rise to 40% of GDP by 2015 after which it is expected to stabilise and decline How realistic is this assumption (e.g. rising future interest rates, rising debt service costs, etc.)? Debt service ratio is increasing pointing towards increasing state debt burden and towards expenditure increases being financed by debt Sharp increase in foreign indebtedness, though its share remains fairly constant over the medium term FFC Submission on the 2011 MTBPS

Economic Outlook: Some Challenges Government balancing act: inclusive growth and job creation together with fiscal sustainability and low inflation Structural challenges Infrastructure: transport and energy (absence of sufficient electricity generating capacity and implications for NGP) Public service delivery Even though the 2010 GHS indicates a slight improvement in service delivery, management and maintenance of service delivery infrastructure are also key FFC Submission on the 2011 MTBPS

Economic Outlook: Some Challenges (Cont.) Other risks: Commodity Prices Research carried out by the Commission suggests that oil price increases would reduce GDP by between 2.2% and 2.5% Impact on government deficit varies widely among the scenarios, ranging from a worsening of 12% to 22% in the floating prices and the fixed price scenarios, respectively Debt Service Costs Necessary for government to borrow in order to pursue countercyclical policies and ensure sufficient service delivery – exposure to foreign exchange risk must be considered Rising personnel costs coupled with increased government dissaving FFC Submission on the 2011 MTBPS

II. Medium Term Spending Priorities

FFC Submission on the 2011 MTBPS Background Average real annual growth rates of most government expenditure components are too high even though government wants to keep increases in expenditure at moderate levels Real annual increases should be kept at around 3% if SA government is to achieve a balanced budget by 2015/16 Thus, these increases pose a further risk to fiscal consolidation All of the categories have higher average real growth rates with the exception of few (general public services, fuel and energy, recreation and culture, and science and technology) FFC Submission on the 2011 MTBPS

FFC Submission on the 2011 MTBPS Job Creation FFC welcomes priority shift in government expenditure towards infrastructural investment as critical vehicle for job creation Capacity constraints Funds earmarked for capital projects remain unspent Question: Are capacity-building initiatives sufficient to improve delivery given increases in infrastructural funding, or is subnational government set to fail on a grander scale? For example, IDIP review has identified a number of problems that are not really dealt with In this regard, Commission’s 2010 recommendations remain relevant FFC Submission on the 2011 MTBPS

FFC Submission on the 2011 MTBPS Health And MDGs Although SA has made some progress in achieving the MDGs, gaps remain Simulations carried out by the Commission show that if the economic conditions do not change, there will be progress in achieving some MDGs but this progress will not be sufficient to achieve all South Africa should be able to achieve MDG 1, but not any of the health MDGs (even when GDP growth of 4.5% is assumed) Further scenarios conducted to investigate the impact on public spending to achieve the MDGs, separately and simultaneously FFC Submission on the 2011 MTBPS

FFC Submission on the 2011 MTBPS Health And MDGs (cont.) Commission’s recommendations for the 2012 in line with 2011 MTBPS on prioritisation of MDGs Emphasis on greater efficiency and cost-savings Important development: NHI Need for government to come up with an interim financing mechanism that is credible Financing of proposed pilots (PES transfer or a conditional grant) Well known that full programme will cost a lot more; poses a fiscal risk The Commission will make LT budget projections under scenarios that reflect different assumptions about future policies for revenues and spending following Government LT financing discussion paper FFC Submission on the 2011 MTBPS

FFC Submission on the 2011 MTBPS Social Security 2011 MTBPS: strengthening selected child welfare programmes – early childhood development services and home and community based child care and protection Commission’s view: proposals worth funding but in the context of reforms to resolve the structural issues in the sector Guaranteeing an effective support/supervision mechanism Ensuring integrated planning of the services rendered by DSD and NGO’s Giving more money to the sector should be guided by the need for a serious policy review about the role of the state and the effectiveness of delivery models FFC Submission on the 2011 MTBPS

III. Concluding Remarks

FFC Submission on the 2011 MTBPS Conclusion A main theme running through the 2011 MTBPS: economic growth slower than expected → revenue growth lower, budget deficits slightly higher Emphasis: need to shift priorities in government spending away from consumption towards infrastructural investment → job creation FFC’s submission on the MTBPS details and highlights key issues emerging from the 2010 MTBPS and tries to link the issues with the FFC’s recommendations that were tabled in May 2011 Resonance with government? Parliament: process MTBPS and take on board FFC’s recommendations FFC Submission on the 2011 MTBPS

FFC Submission on the 2011 MTBPS Conclusion (cont.) Growth prospects pose a threat to achieving the 5 million job creation goal by 2020 Global economy SA should not rely on its global counterparts but should be doing more domestically to find solutions to employment problems FFC welcomes shifts in the composition of public expenditure towards investment and economic development Government should weigh up carefully the impact of increasing spending against the risk associated with increasing taxation rates, spending levels and re-allocating expenditure from capital expenditure FFC Submission on the 2011 MTBPS

FFC Submission on the 2011 MTBPS Conclusion (cont.) Reaching all the health MDGs (child and mother-related health goals) within four years seems unlikely, even impossible National, provincial and local government should further reprioritise expenditures in respect of Equitable Share and Conditional Grants for 2012/13 to move towards attaining MDGs In this respect, Government should continue prioritising MDG 6 (HIV indicators) in the interim as its attainment will have positive impacts on other MDGs (positive spillovers) Time-frame for attaining all outstanding MDGs simultaneously should be extended beyond 2015 to make the task feasible FFC Submission on the 2011 MTBPS

FFC Submission on the 2011 MTBPS Conclusion (cont.) Reaching all the health MDGs (child and mother-related health goals) within four years seems unlikely, even impossible National, provincial and local government should further reprioritise expenditures in respect of Equitable Share and Conditional Grants for 2012/13 to move towards attaining MDGs In this respect, Government should continue prioritising MDG 6 (HIV indicators) in the interim as its attainment will have positive impacts on other MDGs (positive spillovers) Time-frame for attaining all outstanding MDGs simultaneously should be extended beyond 2015 to make the task feasible FFC Submission on the 2011 MTBPS

FFC Submission on the 2011 MTBPS Conclusion (cont.) Important changes promised with respect to NHI Financing of proposed pilots through conditional grant The Commission will make LT budget projections under scenarios that reflect different assumptions about future policies for revenues and spending following Government LT financing discussion paper Proposals to strengthening selected child welfare programmes worth funding but in the context of reforms to resolve the structural issues in the sector FFC Submission on the 2011 MTBPS

Thank You. Financial and Fiscal Commission Montrose Place (2nd Floor), Bekker Street, Waterfall Park, Vorna Valley, Midrand, Private Bag X69, Halfway House 1685 www.ffc.co.za Tel: +27 11 207 2300 Fax: +27 86 589 1038