Finance Minister Trevor Manuel is likely to unveil a more expansionary Budget policy for 2009/10 and the years ahead as he is obliged to increase the deficit in the wake of the global economic slowdown and dramatic fall-off in South Africa's inflation and growth since the October 2008 Medium-Term Expenditure Framework (MTEF), according to Johann Els, senior economist at Old Mutual Investment Group (SA) (OMIGSA).

This is after sticking to a very disciplined fiscal policy (by international standards), with budget deficits of under two percent of GDP since 2005/06.

Els says the 2009/10 budget deficit figure will probably be the most watched number to come out of Manuel's budget speech on Wednesday. In the MTEF it is targeted to rise to -2.0 percent of GDP in 2009/10 from -0.4 percent of GDP in 2008/09. However, with slower economic growth and lower tax collections, this target is no longer achievable without raising taxes, he points out.

Extra tax increases

"We are estimating the actual 2009/10 budget deficit at -R71.2bn (-2.8 percent of GDP), compared to the expected MTEF target of -R52.1bn (or -2.0 percent of GDP), a difference of ?R19.1bn. So if the National Treasury were to stick to its MTEF deficit target, they would have to look for extra tax increases totalling R19.1 bn. This is completely opposite to the situation prevailing in the past several years, in which there was plenty of surplus cash available for tax cuts."

Els points out that, in previous years, the government was sitting with much higher surpluses than originally projected, due mainly to booming revenue collections. As recently as 2006/07, the revenue overrun totalled a substantial R34.8bn. This year, however, revenues have been under pressure, with the shortfall estimated at ?R0.7bn. This is mostly attributable to lower VAT collections and customs duties.

However, Manuel would not opt for tax increases ? a contractionary fiscal policy - in the current economic slowdown, he says. "The Minister must use fiscal policy to support the slowing economy by allowing the deficit to increase to some domestically and internationally acceptable level ? the key question is what this level will be."

Under international norms, explains Els, a government budget deficit of more than -3.0 percent of GDP generally becomes concerning, as government borrowing potentially begins to "crowd out" the private sector and other public sector borrowers, pushing up borrowing costs and making investors nervous.

Els has calculated that, if Treasury allows the deficit to increase to the expected -2.8 percent of GDP, all of the government's current spending plans would be funded, and there would be no need for net tax hikes. Should Treasury want to provide additional support to economic growth by cutting taxes and/or funding additional spending, they would have to lift the deficit further. A -3.0 percent deficit target would add R5.8bn to the budget; a - 3.2 percent deficit target would add R11.0bn and a -3.5 percent deficit target would add R18.7bn.

"So depending on the government's appetite for a wider deficit, anything up to approximately R18bn could be available to help underpin economic growth," explains Els. "The figure will depend on how the National Treasury opts to deal with the challenge of supporting the country's badly faltering economic growth without doing serious fiscal damage. They are well aware of the dangers. A clue to their approach comes from Manuel's comments in presenting the October 2008 MTEF: 'Fiscal policy will continue to balance mitigating global risks with support for higher investment, better public services and rising unemployment.'"

Els says OMISGA believes National Treasury will lift the deficit target above -2.8 percent and provide some combination of tax relief and higher spending. There is a chance they will target the key -3.0 percent level and then look to raise additional taxes elsewhere in order to provide extra tax relief to middle- and lower-income earners. These tax hikes could come from the usual hikes in sin and fuel taxes and possibly even from a temporary increase in the top marginal tax rate.

However, he cautions, personal tax cuts are likely to be somewhat disappointing, targeting the middle and lower income brackets and consisting mainly of bracket adjustments to account for 'fiscal drag', rather than reductions to individual income tax rates.

Although not likely, Manuel could possibly announce some VAT relief on essential foods, Els notes. A one percent reduction from the current 14 percent rate would cost the government approximately R11.7bn. Or a one percent cut in corporate taxes from the current 28 percent rate would cost an estimated R5.7bn. "There is not likely to be a change in VAT, as Manuel has previously ruled this out as being too administratively onerous ? this is also a very costly option. A reduction in company taxes or tax credits is an outside possibility as a way to help stimulate business investment."

Normal hikes in "sin" taxes

We will also get the normal hikes in "sin" taxes ? on alcohol and tobacco ? and the fuel levy, he predicts.

On the spending front, the Treasury is likely to provide extra social spending, such as extending the age for child grants and accelerating the lowering of the male pensionable age (from 65 to 60). Robust infrastructure spending will remain in place, Els believes, with a total of R859bn already provided over the four years from 2008/09 to 2011/12.

"There could even be more spending unveiled for the Expanded Public Works Programme," he adds. "This type of spending acts as an excellent direct stimulus to the wider economy."

Manuel will also likely announce additional spending in the out-years of the Budget for priority areas like health, education and justice, he believes.

Manuel will certainly be revising the budget's macroeconomic forecasts lower, says Els. The MTEF had pencilled in GDP growth of three percent for 2009 and four percent for 2010, while OMISGA is now projecting only 1.0 percent GDP growth for 2009 and 3.2 percent for 2010. The MTEF forecast for CPIX inflation was 6.2 percent for 2009 and 5.3 percent for 2010, and OMIGSA's current CPIX forecasts are 4.8 percent for 2009 and 5.2 percent for 2010.

As for other surprises or issues that could be announced by the Finance Minister, Els says we are likely to learn more details on the revamped social security system, and there could possibly be more announcements on exchange controls.

"What would truly be big surprises for us would be to see a very large budget deficit, big individual tax cuts, large company tax relief or significant exchange control relaxation," he concludes.