Developments through 1995/96

12. After peaking at 8.6 percent of GDP in 1992/93, the deficit of the central government declined to 6.7 percent in 1993/94, falling further to around 6 percent in 1994/95 and 1995/96 (Appendix Table 11).⁴ Government ordinary revenue increased by a cumulative 0.9 percent of GDP during 1994/95 and 1995/96, to 25.3 percent in 1995/96 (Figure 3; Appendix Tables 12 and 13). Virtually all of this increase can be attributed to larger collections of personal and corporate income taxes, as customs receipts rose only marginally—offsetting the decline and eventual elimination of the import surcharge—and revenue from the VAT, excises, and the fuel levy remained relatively constant in terms of GDP. Over the same period, government expenditure fell by 0.4 percent of GDP to 30.5 percent of GDP in 1995/96. An increase in interest payments was more than offset by a large decline in capital expenditure to just 1 percent of GDP in 1995/96. This decline reflected in part a slow rate of expenditure under the Reconstruction and Development Program (RDP), and was the major reason for the increase in the stock of “rollovers” from R 1.5 billion at March 1993 (0.4 percent of GDP) to R 8.9 billion by March 1996 (1.8 percent of GDP; the latest date for which data are available).⁵ Transfers to the provinces were around 14½ percent of GDP, representing 60 percent of non-interest central government expenditure.

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SOUTH AFRICA: GOVERNMENT FINANCES, 1989/90–1997/98 ^1/

(In percent of GDP)

Citation: IMF Staff Country Reports 1997, 082; 10.5089/9781451840933.002.A001

Sources: Department of Finance; South African Reserve Bank; and Fund staff estimates.^1/ Fiscal year ending March 31. Data for 1990/92 are preliminary, budget data for 1997/98.2/ National expenditure including transfers to provinces, but excluding extraordinary transfers.3/ Central government only; including revenue which Is subsequently transferred to the provinces; excludes revenue from sale of strategic clocks of oil.4/ Includes secondary tax on corporations and corporate tax on gold mining.5/ Total expenditure by national and provincial governments, including stocks of rollover funds.6/ Data before 1992/93 not available. Actual data to 1995/98, and budget data for 1998/97–1997/98.7/ Excludes Wages, interest payments, and business subsidies.

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13. The RDP fund was designed to mobilize resources for special initiatives aimed at redressing inherited inequities. The fund was financed by a reduction of planned allocations to spending departments, and funding was to increase by R 2.5 billion annually from 1994/95 through 1998/99. In the event, significant capacity constraints led to large increases in rollovers. These constraints, which are being addressed, included weak management capacity, cumbersome tender procedures, lack of experience with private-public partnerships, and insufficient coordination. The RDP Office was abolished in mid-1996, and the various projects became part of the regular ministry budgets; the RDP fund is now used only for channeling international financial assistance to earmarked projects and programs.

14. Data on economic and functional classifications are only available for total expenditure of the national and provincial governments (Appendix Tables 14, 15, and 16), and include that financed by own revenue of the provincial governments (which is small and is mainly derived from motor vehicle and other licenses). While these data need to be interpreted with care,⁶ they indicate that total cash expenditure of the central and provincial governments declined by a cumulative 0.9 percent of GDP during 1994/95 and 1995/96 to 31.3 percent in 1995/96.

Developments in 1996/97

15. The “headline” deficit of the central government for 1996/97 rose to 5.3 percent of GDP from 4.9 percent in 1995/96. This was 0.2 percentage points of GDP above the budget target, as higher-than-projected revenue was more than offset by higher spending, which accelerated sharply toward the end of the fiscal year. When this “headline” estimate is adjusted to exclude extraordinary receipts such as the proceeds from the sales of strategic oil stocks, the deficit outturn for 1996/97 is 5.6 percent of GDP, and when accrued rather than cash interest payments are included, the deficit was 6.2 percent of GDP, compared with 5.8 percent in 1995/96. The higher-than-budgeted deficit largely reflected the much needed increase in RDP expenditure.

16. Central government ordinary revenue was 0.8 percent of GDP higher than in 1995/96 and 0.6 percent of GDP higher than budgeted. This increase was mainly due to a surge in corporate income taxes, reflecting the rise in corporate profitability and unanticipated higher receipts from the Secondary Tax on Corporations, following the halving of its rate to 12.5 percent. Personal income taxes were buoyed by collections under the third and final tax amnesty,⁷ while collections under the new 17 percent tax on retirement income were somewhat below target. Higher customs revenue from imports of motor vehicles was offset by lower VAT receipts because arrear collections were less than anticipated. However, the overall target of 0.3 percent of GDP for collections of all types of tax arrears through improvements in tax administration was exceeded by a wide margin. Receipts were also boosted by nontax revenue, especially from interest earnings on government deposits, owing to higher interest rates than had been expected. Extraordinary revenue, resulting form the sale of the strategic oil stocks was in line with the budget.

17. Central government expenditure increased by 1.2 percent of GDP in 1996/97 to 31.7 percent of GDP, or 0.8 percent of GDP higher than budgeted. The increase in interest payments by 0.6 percent of GDP was in line with projections, and reflected in part the take over of the former debts of the four TBVC homelands by the central government. Other current expenditure fell by 0.9 percent of GDP compared with an anticipated fall in current expenditure of 1.5 percent of GDP in the budget; transfers to the provinces declined by 0.2 percent of GDP or half of what had been anticipated in the budget because some provinces overran their original allocations and were provided with additional transfers in the Adjustments Budget. Declines in the central government’s own current expenditure made up the balance of the adjustment (a disaggregation by type of expenditure is not yet available). Capital expenditure rebounded—rising from 1.0 percent of GDP in 1995/96 to 2.6 percent in 1996/97—reflecting in part the pick up in RDP expenditure.

18. As noted above, the economic and functional classifications of the 1996/97 Adjustments Budget are not yet available. Comparing instead the 1996/97 budget with the 1995/96 budget, the data for the central and provincial governments indicate that outlays on wages and salaries increased sharply, with some offset in current transfers to businesses, households, and other units of government. The increase in wage and salary spending reflected the three-year agreement on civil service conditions that became effective in July 1996, which included a rise in wages of salaries of R 8.5 billion (1.5 percent of GDP) in the first year of the agreement and R 6.5 billion in each of the following two years. In addition, the agreement provided that any savings that arise from the “rightsizing” program would be used for further wage increases for those that remain in the civil service (see Section III).

19. Two tax incentive schemes were introduced during 1996 in the context of the GEAR. The accelerated depreciation allowance provides for straightline depreciation for new manufacturing plants and equipment over three years (rather than five) and for buildings over ten years (rather than 20) that are installed between July 1996 and September 1999. The income tax holiday can be granted for two years for each of three criteria that are met by new manufacturing investments valued at more than R 3 million starting from October 1996. The criteria are labor absorption (based on the value added devoted to wages and salaries), regional location (based on the assessment of regional potential and need for development, as determined by the Department of Trade and Industry), and industrial policy (based on priority industries that are determined by the DTI, using criteria such as labor intensity, industries with strong economic linkages, critical industries affected by the tariff reform, and global potential).

20. As in previous years, the 1996/97 deficit was in the main financed through the issue of long term bonds (Appendix Table 17). These bonds were sold with an average coupon rate of 12.83 percent, compared with a weighted average yield of 15.87 percent. The consequent discount on the sale of bonds amounted to R 6.7 billion.⁸

21. Total debt of the central government (at face value) has increased rapidly in recent years, rising from 39.5 percent of GDP in 1991/92 to 55 percent in 1996/97 (Appendix Table 18). Of this increase, 10.4 percentage points reflect the discount on the sale of government bonds, as described above (3.4 percent), the takeover of the overdraft debts of the former TBVC homelands that had been guaranteed by the central government and that are being gradually switched to Treasury bill debt (2.4 percent), the recapitalization of part of the actuarial underfunding of the public pension fund (1.7 percent),⁹ and the transfer to the South African Reserve Bank (SARB) to cover the losses in forward exchange operations (2.9 percent).¹⁰

22. As at March 31, 1996, contingent liabilities of the central government stood at R 134.8 billion (27 percent of GDP in 1995/96). The largest components were the underfunding of the government pension fund (R. 54.4 billion) and the government guarantees (R. 66.5 billion). Of the latter, R 55.5 billion were guarantees on public enterprise debts, mainly for the transport company Transnet (R 25.2 billion), the telephone company Telkom (R 10.0 billion), and the electricity company Eskom (R 6.2 billion). Revised guidelines for the issuance of new guarantees were implemented in October 1996; since then, the government is charging a fee to discourage the use of such guarantees.

The 1997/98 budget

23. On March 12, 1997, the Minister of Finance presented to Parliament the budget for fiscal year 1997/98. In line with the government’s commitments under the GEAR, the budget targets a decline in the overall deficit from 5.6 percent of GDP in 1996/97 to 4 percent in 1997/98 (excluding extraordinary revenue and the difference between accrued and cash interest payments in both years). The budget is based on the assumptions that real GDP growth will be 2.5 percent and that the GDP deflator will increase by 8.5 percent in 1997/98, compared with 3.7 percent and 9 percent, respectively, in 1996/97. Given that ordinary revenue has been held virtually constant at 26 percent of GDP, the whole adjustment effort is to come from a decrease in expenditure.

24. To achieve the revenue targets, the budget includes the following measures: (i) modifications to the personal income tax—including a change in the threshold rate, an increase in the nominal value of the tax bands, and a reduction in the number of tax bands from 8 to 7—which on balance avoid fiscal drag on low income earners (those below R 30,000 a year) but allows some drag on all other income earners; (ii) an increase in the taxation of fringe benefits such as company cars, travel allowances, and housing and holiday accommodation; (iii) the broadening of the coverage of the 17 percent tax on the gross interest and net rental income of retirement funds, which was introduced last year, to unit trusts and certain interest-bearing instruments; (iv) the unification of the taxation of lump sum payments from public and private sector pension funds (from March 1, 1998; acquired rights were grandfathered) and the reduction of the tax advantage of the transfer of public sector pension fund balances to provident funds; (v) the halving of the market securities tax to 0.25 percent, while removing the exemption for purchases by foreigners; and (vi) increases in specific excises (especially for tobacco and alcohol) and stamp duties, and a halving in the ad valorem excise rate of many commodities to a maximum of 15 percent.¹¹ In addition, further improvements in tax administration as a result of the merger in April 1996 of the Inland and Customs Revenue Services into the South African Revenue Service (SARS), the cash bonus scheme introduced at the SARS, and the forthcoming move to make the SARS autonomous from the civil service, are projected to yield R 2.5 billion (0.4 percent of GDP).

25. On the expenditure side, noninterest current expenditure of the central government is budgeted to decline by 1.3 percent of GDP—most of it as a result of a decrease in central government transfers to provincial governments—while capital expenditure of the central government is to decline by 0.5 percent of GDP. On an economic basis—where the data relate to all spending by the central and provincial governments and are subject to the caveats noted above—expenditure on goods and services is projected to decline by 0.5 percent of GDP to 15.8 percent, reflecting a slight decline in the wage bill, to 11.9 percent of GDP, and a reduction in transfers to business and other units of general government. On a functional basis, expenditure declines are forecast in the areas of defense, education (due to the rightsizing program; see Section III), and economic services, while increases are allocated to housing and welfare. With regard to business subsidies, recently the government shifted industrial promotion from the export subsidy scheme (GEIS) to various supply side measures, such as the promotion of industrial clusters and corridor developments, and the tax incentives program described above.

26. As previously, the deficit is to be financed almost wholly through the issue of government securities in the domestic market; the government will again issue debt at a discount with a coupon rate of some 2 percentage points below the expected yield. The lower deficit and the proceeds from privatization that accrue to the central government and those from the sale of strategic oil stocks will help keep the ratio of government debt to GDP at 55 percent, after including the planned takeover of old debts of Namibia to South Africa (0.2 percent of GDP).

27. The significant progress made by South Africa on a variety of structural reforms toward strengthening budgetary operations and tax administration is outlined in Section III and the new intergovernmental relations are outlined in Section IV.

The Balance of Payments

35. The external current account registered a deficit of 0.3 percent of GDP in 1994—the first since 1984—owing to the rapid growth in imports, reflecting the pick up in economic activity, and a slowdown in exports. The deficit widened to 2.1 percent of GDP in 1995, as imports continued to grow at a fast pace (Appendix Table 23), and despite an increase in the volume of nongold exports and little change in the international terms of trade. Imports of capital goods were especially pronounced, suggesting that, as in 1994, investment was the most important factor behind the fast import growth. The current account deficit declined to 1.6 percent of GDP in 1996, with a similar improvement in the trade balance reflecting a continued strong export performance and a marked slowdown in import growth.

36. Exports picked up momentum in the second half of 1996 as a result of a number of factors, including the completion of some of the export-oriented “mega investment projects” (Alusaf, Columbus Steel, and Namakwa Sands), which contributed significantly to the strong export performance of the manufacturing sector; the rebound in agricultural production owing to favorable weather conditions, which led to the rapid growth of agricultural exports; and the depreciation of the rand. Moreover, access to new markets, relatively strong growth in the main industrial countries, and high growth in the emerging economies also contributed to the firm demand for South African exports. While the volume of nongold exports increased by 11 percent, compared with 14 percent in 1995 (Appendix Table 26), the increase was a modest 2.6 percent in U.S. dollar terms, compared with 22.5 percent in 1995, reflecting lower export prices, as exporters seem to have used the depreciation of the rand to increase market shares. Accordingly, while the rand depreciated in nominal effective terms by 21 percent in 1996, the unit value of nongold exports only increased by 6 percent in rand terms.

37. The value of gold exports declined in U.S. dollar terms by 1.5 percent in 1996, owing to a fall in production that more than offset the increase in prices. The average U.S. dollar price of gold increased by less than 1 percent in 1996, as prices remained firm through the first half of the year but fell in the last quarter to US$369.2 an ounce by December 1996 (US$344.5 an ounce in May 1997), compared with a peak of US$404.8 an ounce in February 1996. The share of gold in total merchandise exports declined from more than 28 percent in 1992 to 21 percent in 1996.

38. The growth of imports fluctuated markedly in 1996. It moderated in the first quarter, but picked up in the second and third quarter, reflecting some strengthening in aggregate domestic demand and in anticipation of a further depreciation of the rand, and turned negative in the fourth quarter largely owing to a decline in domestic demand. For the year as a whole, imports remained flat in 1996, after growing by 26 percent in 1995. Import growth in volume terms slowed to 7.6 percent in 1996, compared with about 16 percent in the previous two years. Intermediate goods and capital equipment continued to account for a large share in total imports. The pass-through of the depreciation of the rand on import prices was limited as the unit value of imports increased by 7.7 percent in 1996, at about the pace of increase in the previous two years, when the value of the rand remained broadly stable.

39. The deficit in the services account declined marginally from 3.3 percent of GDP in 1995 to 3.1 percent of GDP in 1996. This was the result of a marked further increase in tourist receipts, partially offset by higher payments for services associated with trade—mainly freight and insurance—and higher interest payments owing to the rise in South Africa’s foreign debt.

40. Following the strong capital inflow that began in the second half of 1994, the surplus in the capital account declined from US$5.3 billion in 1995 to US$0.9 billion in 1996 (Appendix Table 28). This reflected a marked change in investor sentiment about South African assets. In particular, net inflows of long-term capital declined from US$4.2 billion in 1995 to US$1.1 billion in 1996, while net flows of short-term capital (net of errors and omissions) became slightly negative. The net inflow of long-term capital largely reflected an increase in borrowing by the public sector that exceeded the levels of 1995 and more than offset the long-term outflows by the private sector. Government borrowing comprised the Euro-sterling issue of £100 million in January 1996, the Eurobond issue of DM 500 million—which was primarily aimed at refinancing a maturing bond issue—and a bond issue of US$300 million in the U.S. market. Public corporations were also net borrowers. By contrast, private long-term capital inflows declined throughout the year and became substantially negative in the fourth quarter, reflecting the repayment of foreign debt obligations, net sales by non-residents of securities on the Johannesburg Stock Exchange, and an increase in assets held abroad by South African companies and nonbank financial institutions.

41. Total assets swaps (see Section V for a description of this mechanism) authorized since the inception amounted to the equivalent of US$5.9 billion by end of 1996, but only US$3.7 billion had been utilized; of this amount US$2 billion was swapped in 1995 and US$1.7 billion in 1996. Notwithstanding the increase in the ceiling in 1996 on swap operations, the rather low use of this mechanism indicates that the existing limits are not binding. This may reflect a limited interest by foreigners in such operations during 1996, perhaps owing to the volatility in the rand, as suggested by the decline in swap operations from US$663 million in the first quarter of 1996 to an average of US$342 million in the subsequent three quarters.

42. After a substantial drop in 1993, and a further decline in the first half of 1994, net international reserves recovered with the surge in capital inflows in the second half of 1994 and in 1995.¹³ Net international reserves peaked at US$3.5 billion in the fourth quarter of 1995, or about 1.3 months of imports of goods and nonfactor services (Appendix Table 30), after having repaid US$0.7 billion in reserve-related external liabilities. However, reserves came under pressure during 1996, declining by more than half by the third quarter of 1996, and were US$1.6 billion by the end of the year. (Notwithstanding the pressures on reserves, the SARB did not make use of its external lines of credit through 1996.) In addition to intervening in the spot exchange market, the SARB intervened heavily in the forward foreign exchange market, raising the NOFP from nearly US$7 billion in mid-February 1996 to about US$22 billion in December 1996—an increase equivalent to some 6 months of merchandise imports in that period.

43. As indicated above, there was a marked strengthening of sentiment in early 1997, which resulted in large capital inflows and an increase in net international reserves to a record level (US$3.7 billion) in May 1997. In a departure of previous policy, the SARB made use of the external lines of credit by the equivalent to R 2.5 billion through April 1997, but repaid R 0.7 billion in May. The NOFP has gradually declined to US$17.8 billion in May 1997.

44. In line with the large capital inflow experienced in 1995, South Africa’s total external debt (denominated in foreign currency) increased by nearly US$4 billion to US$22.3 billion, or 24 percent of GDP (Appendix Table 29). By end-June 1996, this stock had fallen to just below US$21 billion as a result of the sharp reversal in capital flows and a reduction in long-term private debt—from US$12.5 billion at end-1995 to US$11.2 billion by June 1996; total private sector debt declined by US$1.7 billion between 1995 and mid-1996, to about 57 percent of South Africa’s external debt. At the same time, the share of short-term debt in total debt increased from less than 40 percent in 1994 to about 46 percent in June 1996, following the large short-term capital inflows in 1995.

Trade liberalization and trade agreements

45. Considerable progress has been made in rationalizing the external trade regime over the last few years. A trade reform initiative was launched in 1994 based on the government’s application to the Uruguay Round of Trade Negotiations. The reform aims to eliminate quantitative import restrictions; standardize tariff rates at six levels; reduce the number of tariff lines to the six-digit Harmonized Code level by the end of 1999; reduce the maximum tariff rates to 30 percent for industrialized goods and 36 percent for agricultural goods, with “sensitive” industries—such as clothing, textiles, and motor vehicles—maintaining the higher tariff rates and longer adjustment periods.

46. Under the reform, South Africa replaced during 1994–95 most quantitative restrictions and formula duties with ad valorem tariffs for most manufactured products and a number of agricultural products, and adopted tariff bindings covering 98 percent of imports to become effective in 1999. Nominal rates of protection were reduced—even though most tariffs were already well below the agreed WTO tariff binding rates when the Uruguay Round negotiations were concluded. The tariff structure was simplified through the near halving of the number of tariff lines to about 5000 and through the reduction in the number of ad valorem rates. Reforms of the trade and marketing of agricultural products were accelerated in 1995, with the deregulation of prices, the abolition or reform of agricultural control boards, the conversion of import controls to ad valorem duties. Finally, the last remaining import surcharge, on luxury goods and household appliances, was abolished in October 1995.

47. During 1996, the schedules for the reduction of tariffs over 5–7 years were finalized, and a number of tariffs on commodities that were either not produced in South Africa or which were imported inputs were abolished. Overall, the import weighted average tariff rate fell from 11 percent in 1995 to 10 percent in 1996, but the reduction in tariffs on inputs ahead of those on final goods resulted in an increase in effective protection, which raised the existing biases against exports, labor absorption, and growth. Finally, the three-year process leading to the elimination of the primary export subsidy, GEIS, initiated in 1995, was brought to an end with the abolition of the export subsidy program to take effect from mid-1997, six months ahead of the original schedule.

48. Negotiations on regional free trade agreements with the South. African Development Community (SADC) ¹⁴ and the European Union (EU) continued during 1996. SADC was originally established in 1980; its agenda was refocused in 1992 toward deepening economic integration, including in monetary and fiscal policies, exchange rate and trade regime, and mobility of capital and labor. The Trade Facilitation Protocol, drafted in February 1996, envisages a Free Trade Agreement (FTA) among SADC member countries with reciprocal tariff reductions. The proposed FTA would be phased-in over an eight-year period, and South Africa was considering accelerating the elimination of tariffs on imports from SADC before the reciprocal SADC tariffs on South African exports were eliminated under the FTA. The review of the revenue-sharing formula for the Southern African Custom Union (SACU) is nearly completed;¹⁵ it aims at helping avoid sharp reductions in South Africa’s transfers to the other members as a result of its unilateral tariff reduction.

49. The negotiations with the EU have proceeded slowly. After some delay, access by South Africa to the Lome convention, except for its trade preference provisions, was formalized in April 1997. The main benefits to South Africa are the right by South African companies to tender for contracts funded under the EU development fund and to participate in the joint bodies of the African Caribbean and Pacific (ACP) states and the EU—the joint assembly and ministerial meetings—where negotiations on the future of Lome are now taking place. Regarding the FTA proposed by the EU, which envisaged the asymmetrical phase-in of a free trade area over 10–12 years, the South African authorities are concerned that the EU offer has not adequately addressed South Africa’s trading relations with the region and the fiscal implications for SACU, that it excludes 40 percent of South African agricultural exports to the EU, and that it would expose local farmers to subsidized European agricultural products by removing the current tariff protection.¹⁶ As a consequence, discussions have continued at a slow pace.

Capital controls liberalization

50. A major step in liberalizing exchange controls was taken with the elimination of the financial rand mechanism in March 1995, and hence the removal of all exchange restrictions on nonresidents. Progress was also made in relaxing controls on residents in various steps, underscoring the authorities’ commitment to the gradual elimination of exchange controls on residents while ensuring that these steps were not disruptive to financial markets. For a description of these steps, see Section V.

51. It is important to note that the authorities’ approach was not simply to liberalize controls in a sequence of steps that allowed different types of capital transactions one at a time, but to open a number of new windows for resident capital transactions, each subject to a cap. In this way, an increasing array of forms of resident capital transactions have been permitted, but the risks of major aggregate outflows were limited by the caps applied to each type of transaction. This feature of the step-by-step approach allowed the authorities to gradually increase the range of authorized capital transactions, as well as the scope of each of these transactions by raising the caps. The authorities intend to continue with this approach until all types of resident capital outflows are permitted and until the caps are no longer binding, and the risk of major capital outflows minimized.

The Eurorand market

52. Beginning in September 1995, a series of rand-denominated bonds were issued in the European market by non-South African entities, including Merrill Lynch, EBRD, and the Government of Sweden. Total issues amounted to the equivalent of US$1.8 billion by mid- February 1996. The coupon rate fell from 15 percent on the initial issues to as low as 13 percent on issues in late January and the first half of February 1996. Activity in the Eurorand market slowed thereafter, but picked up markedly in early 1997, with total issues exceeding the equivalent of US$10 billion by end-May 1997. In contrast to the previous issues, which had been short- or medium-term, a number of the issues in 1997 have carried maturities of 10 years or longer, with one issue by the EBRD having a maturity of 30 years. The coupon rate has generally been above 14 percent in 1997.

53. The development of the Eurorand market is an important step in the development of rand capital markets. Thus far, these issues appear to be largely held in the stable retail market, and there was no evidence of large sales during 1996. The market allows high credit quality international issuers to lower their borrowing cost in the Eurorand market vis-à-vis the sovereign issuer in the domestic rand market. Issuers swap the rand with a top-rated bank or investment bank in London, who then hedges the acquired rand exposure with the outright purchase of domestic rand gilts, frequently as part of an asset swap. The impact of these operations on reserves is generally thought to be positive or neutral.