This Selected Issues paper highlights that aided by the easing of political uncertainties after the national elections in early 1994 and by the cautious stance of policies adopted by the new administration, economic performance and investor sentiment in South Africa strengthened markedly. Nonagricultural value-added grew by 4 percent in 1995, led by a sharp increase in real gross private fixed investment. In contrast, developments in 1996 were characterized by a shift in investor sentiment and unrest in the foreign exchange markets.

Abstract

This Selected Issues paper highlights that aided by the easing of political uncertainties after the national elections in early 1994 and by the cautious stance of policies adopted by the new administration, economic performance and investor sentiment in South Africa strengthened markedly. Nonagricultural value-added grew by 4 percent in 1995, led by a sharp increase in real gross private fixed investment. In contrast, developments in 1996 were characterized by a shift in investor sentiment and unrest in the foreign exchange markets.

III. STRUCTURAL FISCAL REFORMS

105. The Government of National Unity has been designing and implementing substantial structural reforms in the public finances area. Moreover, the pace of fiscal structural reform on a variety of fronts has accelerated, and the process has been reinforced with the announcement of the GEAR, which in the public finances areas aim at (i) reducing government dissaving by lowering the size of the budget deficit; (ii) reallocating expenditure in ways that enhance economic growth and improve income distribution; and (iii) improving efficiency of the public sector. This section outlines some of these reforms, focusing on developments during the last year.

A. Poverty Alleviation and Social Sectors

106. Poverty alleviation is one of the most pressing problems facing South Africa. A comprehensive survey on poverty undertaken in 1993 indicated that the poorest 40 percent of households (representing 53 percent of the population) spend less than R 385 per adult per month (1993 prices, equivalent to US$118), with the poorest 20 percent of households spending less than R 225 a month. Further, poverty is concentrated in certain communities and groups: 95 percent of the poor in South Africa are black people, 75 percent live in the rural areas, 53 percent are unemployed, and 45 percent are children under 16 years. More than three-quarters of the poor have no access to electricity, running water in the household, or modern toilets, and 90 percent did not complete secondary school. Several initiatives have been launched in the areas of welfare and land reform, and an update on poverty and inequality will be released later this year by the Office of the Deputy President, drawing on assistance from the World Bank and UNDP.

107. Social security and other welfare assistance play an important role in South Africa. In 1996/97, some 2.7 million people received some form of assistance. Of these, 64 percent were elderly (who receive the old-age pension),25 26 percent were disabled, and the balance were children, war veterans, and families. Social security assistance (old-age and veterans pensions, disability, child and family maintenance, and foster parent grants) accounted for more than 85 percent of the 1996/97 social services budget, while welfare assistance (elderly care in homes, child and family welfare, probation services, drug rehabilitation, community centers, population development) and capital expenditure comprised the balance.

108. Progress in implementing reform in critical social sectors—health, education, and housing—has been slower than envisaged in 1994, mainly as a result of the wide-ranging consultation efforts initiated by the Government ahead of the design of reform agendas in these areas. Rapid progress has also been delayed by a variety of physical and management bottlenecks to establish and operate the new procedures. Nonetheless, these constraints are being addressed, and expenditure and reform in these areas are accelerating, financed in part through a decline in military expenditure.

Welfare reform

109. A White Paper on the Social Welfare Services was tabled in Parliament in February 1997. In this context, following the merging of the 14 previous administrations into a single system, the Department of Welfare is implementing a five-year plan that aims to combine public and private financing options to alleviate poverty and to reduce racial and gender discrimination in the provision of social services. During this period, the social welfare delivery system will be restructured, with a focus on community development and less emphasis on specialized service. At present, nongovernmental agencies do the bulk of the delivery of non-social security welfare services, but they often lack resources. The Department of Welfare also plans to reduce fraud with the establishment of a National Social Grants Registry, first by concentrating on new registrants and then incorporating the private and civil service pension funds into the Registry.

110. Major changes have been announced for the child maintenance grant. The grant is presently set at R 430 a month for parents plus R 135 a month per child for up to two children younger than 18. Given that only 350,000 children receive the current benefit, very few of them in black families, the system is about to change. The Report of the Lund Committee on Child and Family Support that was issued in August 1996 recommended, inter alia, that the current scheme be replaced with a flat-rate, means-tested child benefit to be phased in over five years. This recommendation has been accepted by Cabinet, and a phased transition is scheduled to commence in August 1997, replacing the present system with a benefit set at R 75 a month per child six years old or younger. The new scheme is expected to benefit 3 million children. The cost of the new scheme is expected to be some R 2 billion—nearly double the current scheme.

Housing

111. The housing needs of South Africa are considerable; the urban housing backlog is variously estimated at around 1.3 million units, and that for hostels and rural housing at up to 1.7 million units. In addition, given population growth, there is a need for 200,000 new housing units per year.

112. The housing subsidy program was initiated in 1994. It offers up to R 15,000 per household and is intended to benefit up to 300,000 families a year; the average subsidy to date has been R 13,400 per application. There are two types of housing subsidies. Project-linked subsidies provide housing to developers within projects that have been approved by Provincial Housing Boards, who then re-sell the house at below market prices to an individual household. Between March 1994 and December 1996, 352,100 such houses had been initiated, of which 90,500 had been transferred to the final owner. Individual subsidies enable persons to acquire an existing property or a property not located in a project approved by a Provincial Housing Board; over the same period, 39,400 such subsidies had been provided. The delivery of housing has been slower than initially envisioned, owing to uncertainty over the initial nature of the program and administrative deficiencies, lack of technical and managerial capacity, a vague line of authority at provincial and local government levels, and slow delivery of the essential infrastructure and of the upgrading of services in disadvantaged areas. As these constraints are being addressed, the delivery of housing, electricity, and water is gaining momentum.

113. Several other special housing programs have been initiated at the national level. The Mortgage Indemnity Fund. (MIF) was established in June 1995 to protect financial institutions against losses due to poor loan recovery and encourage them to lend to previous “red-lined” areas. Almost 52,000 new housing loans in such areas have been granted since the establishment of the MIF, with a combined value of more than R 6 billion; the first claims against the MIF (which has a reserve of R 450 million) are expected in 1997. The National Housing Finance Corporation was established in April 1996 to promote non-traditional sourced lending for housing, and its activities will commence in 1997. In addition, since June 1995, Servcon has assisted occupants that had fallen into arrears on servicing their housing debts by either buying the property at subsidized rates, or relocating to a more affordable property. By September 1996, 3,400 sales and 3,900 relocations had been concluded.

Health

114. About 11 percent of total government expenditure or 3.5 percent of GDP has been allocated to health services. Nevertheless, the accessability and quality of health services within South Africa varies significantly, and basic health indicators such as infant mortality are poor. Expenditure had been weighted towards care in hospitals; in 1992/93, just 10 percent of total public expenditure was spent on non-hospital primary services. Several initiatives to address these problems have been implemented in recent years. From 1994, free health care was made available to pregnant women and to children under six years; partly as a result, the share of primary care in total expenditure had increased to 20 percent by 1995/96. Implementation of a program designed to restructure the national health system and provide universal health care was initiated in 1996. To support this program, 126 new clinics had either been built or were under construction by February 1997, and for the year as a whole, a further 270 new clinics and the upgrade of 326 clinics are planned, as is the provision of a further 150 mobile clinics. To encourage the use of these facilities by all citizens, hospitals will-charge users fees when patients bypass the free primary care facilities in favor of hospitals. From April 1996 all permanent residents have been granted free access to publicly funded primary care.

115. Given budget constraints, the shift in public resources to primary health implies a corresponding reduction in public resources provided to hospitals. Yet reconstruction of the hospital system is also needed; a recent audit of hospitals indicated the cost for rehabilitation or replacement program at R 8 billion over 5–10 years. Several supplementary financing options are being considered, including withholding by hospitals of the user fees, and mandatory private insurance for formal sector employees and its retirees for a minimum package of hospital benefits. The fee for this insurance would be based on income and the number of dependents, and the insurance fund would not be allowed to exclude individuals on the basis of their health risk.

116. Finally, several programs have been launched to promote better nutritional standards. The National Nutrition and Social Development Program distributes around R 400 million annually to support small-scale, agricultural and income-generating projects, and to provide food assistance to pregnant women and young children. In addition, the Primary School Nutrition Program disburses around R 500 million annually to 12,300 schools; in 1996, the program provided food equivalent to 25 percent of the daily energy requirements to 3.2 million children.

Education

117. Education reform is a national imperative—illiteracy levels are around 20 percent—but rapid progress has been difficult. Expenditure on education has been more than 22 percent of the total and some 7 percent of GDP in recent years. The share devoted to primary and secondary schools (around 75 percent) is comparable to that in other countries. However, within sectors, spending has been highly inequitable and its return on the level of resources has been low. In 1991/92, one third of total spending was devoted to the education of white children (who represented 13 percent of the school-aged population) and one half for the education of black children (who were 75 percent of the school-aged population).26 As a result, average teacher-pupil ratios vary between 1:38 to 1:47 in schools with predominantly black children depending on the region, compared with around 1:25 in schools with predominantly white children. In addition, the budget share devoted to personnel expenditure is high and growing (around 75 percent in 1991/92, and almost 90 percent in 1997/98) with the consequence that few resources are left for expenditure on quality-enhancing instructional materials and other needs, such as upgrading of school buildings. Relatively high wages are in part the consequence of a policy whereby teachers’ remuneration is linked to academic and professional qualifications rather than to academic responsibility; the net effect is that one third of the teachers are actively in training for subjects that are often not related to their current responsibilities, and that around one-third of teachers are inadequately trained. The system is also overburdened by a rapid rise in enrollment, owing in part to the increase in the number of years of guaranteed free education from 9 to 10 and the continuing high repeater ratios (at up to 50 percent for grade 1 alone, and around 20 percent for the whole school system).

118. In an attempt to deal with some of these issues, the 15 former departments of education have now been merged into a single unit, and national norms for teacher-pupil ratios of 1:40 for primary schools and 1:35 for secondary schools have been established. However, it has proven difficult to transfer teachers from areas where retrenchment is necessary to areas where teachers are needed. In addition, the South African Schools Act was passed in 1996, establishing a uniform framework for the organization, governance, and funding of schools, and a National Qualifications Framework has been established. A Green Paper on Higher Education Transformation was published in 1996 for comment, and a study on senior secondary schooling is in progress.

Social infrastructural development

119. Several major social investment programs are underway in the context of the restructuring of expenditure and the alleviation of poverty. The telephone connection program is on track (a further 2.8 million new connections in houses, schools and clinics will be installed in the next five years (see below) as is the electrification program—1.75 million new connections over the period 1994 to 2000). Community water supply and sanitation programs have accelerated, and by the end of 1996, 700 water projects which will eventually benefit more than 6 million people had been committed. Expenditure on municipal infrastructure and amenities increased during 1996 as part of the national grants program, which worked directly with low-income municipalities via the Municipal Infrastructure Program coordinated by the national government. Under this program, 1,089 projects have been identified, of which 115 were completed and 369 are under construction. Private-public partnerships for delivery of municipal services and infrastructure have been initiated.

Land reform

120. Land reform efforts include a land restitution and land redistribution program. Restitution for those dispossessed of their land under apartheid is being addressed by the Land Claims Court, which became operational in 1996; 11,000 claims have been lodged, and 25 cases are expected to be finalized during 1997 (affecting around 50,000 people). The land redistribution program aims to increase access to the land market by the poorest groups through a market-based reform. The program includes a flat-rate grant of R 15,000 per household to either acquire rural or urban land, secure tenure rights, provide basic infrastructure on land and improve it, and/or acquire equity in an existing agricultural enterprise. Taking up this subsidy makes the household ineligible for the housing subsidy described above; thus far, planning grants have been provided to 240 communities. Finally, the Extension of Security of Tenure Bill is expected to be tabled shortly and aims to protect rights of existing tenants from “unfair” evictions.

B. Other Reforms

Reform of the civil service conditions of service and pension reforms

121. On April 19, 1996 an agreement was reached within the Chamber of Public Service Bargaining Council on a three-year adjustment package for a unified set of conditions for the civil service of the central and provincial governments.27 The agreement addressed the rationalization and simplification of salary scales and grades, a “rightsizing” civil service employment program, and the restructuring of public pension benefits. The agreement stipulated an increase in the cost of improvements in the conditions of service of R 8.5 billion over the 12-month period starting July 1, 1996—of which R 1 billion was to be paid from departmental savings—and a further R 6.5 billion increase in the wage bill for each of the two subsequent years. Furthermore, the agreement established that any budgetary savings arising from a voluntary rightsizing program that began on May 1, 1996 be used to fund additional salary increases of up to R 4.7 billion a year in 1997/98 and 1998/99. The Minister of Finance also agreed to a moratorium on mandatory retrenchment, and government ministers announced the intention to reduce staff positions by 300,000 over three years (out of 1.3 million employees at the national and provincial levels).

122. The various civil service pension funds were unified into a single fund, with the initial pension based on the average salary of the last 24 months of service (rather than that of the last day of service), portability and a cash resignation benefit were enhanced, and the government’s contribution was lowered from 18 percent of the wage bill to 17 percent. The net effect of these changes to the pension funds was to reduce the level of funding of the civil service pension fund by some 2 percent (R 2.7 billion), although the financial position of the pension fund is expected to improve gradually as the current limit on the total assets that the pension fund can invest in traded stocks is raised from 20 percent to 65 percent.

123. Between June 1996 and March 1997, the voluntary retrenchment program led to the departure of 39,800 employees out of 58,000 applicants, and 18,250 unfilled funded positions were cancelled. However, during the second half of 1996 (latest available data) total employment at the national government declined on a net basis by only 4,400 and at the provincial government by only 800, reflecting in part the need to replace several of the skilled workers that departed under the voluntary severance program. In March 1997, the Minister of Finance announced that the voluntary severance program needed to be reviewed because the current costs of retrenchment were prohibitive.

124. Other changes in the pension system have also been initiated. Following the recommendations of the Smith and Katz Commissions, the government established the National Retirement Consultative Forum, which met in January and February 1997. The Forum established several theme committees, and a Green Paper is expected to be released for public comment in October 1997. The theme committees recommended that (i) an old-age pension grant should be retained and financed from general revenues, methods of phasing out the means test should be considered, and the compilation of a national register of social grants should be accelerated; (ii) a common private sector retirement age for all retirement vehicles should be established, a system of tax deferment should be retained with tax relief on contributions, and short- and long-term strategies to promote saving for retirement should be formulated; (iii) equality of tax treatment for public and private funds should be introduced by March 1998 (including for local authorities and parastatal plans), the investment strategy of the Government Employees Pension Fund should be considered, as should alternative public pension arrangements; and (iv) the appropriateness of using pension funds as vehicles to fund post-retirement medical benefits should be investigated, and the actuarial position of such schemes should be supervised.

Medium-term expenditure framework

125. The national and local authorities are establishing a medium-term expenditure framework for the national and provincial governments. This framework will be an instrument to better assess and scrutinize the financial implications of current and alternative departmental policies and spending programs within budget constraints, enable spending ministries to improve planning and reduce the size of their rollovers, and encourage greater efficiency within spending ministries. The authorities intend to incorporate a three-year framework into the 1998/99 budget, which will establish expenditure by the national and provincial governments. Co-ordination between the different levels of government will be undertaken through the Budget Council, as well as between respective spending ministries at the national and provincial levels. At the same time, the authorities are developing a medium- term personnel framework, with assistance from the British Department for International Development (formerly the Overseas Development Administration), to rationalize employment in the areas of health, education, police, and defense.

The Katz Commission

126. In June 1994, an independent tax commission (the Katz Commission) was appointed to conduct a review of selected aspects of South Africa’s tax structure and, in particular, to provide recommendations for tax changes, most of which have been adopted. A Tax Advisory Committee is also engaged in a detailed study of tax issues, providing input to the Katz Commission. To date, the Commission has released five interim reports (November 1994, June and December 1995, and April and May 1997). The first three recommended changes in (i) the personal income tax (by reducing the number of brackets from ten to five, instituting a flat rate of nine percent on annual taxable income up to R 30,000, and setting a maximum marginal rate of 45 percent on incomes above R 150,000); (ii) the corporate income tax (by reducing the Secondary Tax on Corporations and eventually replacing it with full or partial imputation system, and the implementation of a presumptive tax on company gross assets); (iii) the VAT (by broadening the base by narrowing zero-rating and eliminating exemptions); and (iv) the taxation of retirement income (by establishing equal treatment of discretionary and contractual savings and of public and private schemes, and raising the taxation of retirement income in the form of lump-sum withdrawals). They also recommend a strengthening of tax administration by modernizing computer facilities, improving tax assessment and audit procedures, enhancing taxpayer education, and endowing the revenue service with more flexibility in respect of employment and wage policy.

127. The most recent two reports covered the taxation of capital transfers, and whether income taxes should be based on world wide income of residents regardless of source (the “residency” principle), or on the source of income regardless of residency of the recipient (the “source” principle). On the former, the Katz Commission recommended that donations and estate duty taxes be retained and not combined into a single tax, the exemption from estate taxes for bequests in favor of a surviving spouse be retained, an exemption for bequests to specified non-government organizations be allowed, a capital gains tax be periodically imposed on trusts that intend to skip generations, and distribution of capital from trusts be subject to a capital transfer tax. On the latter, the Katz Commission recommended that the taxation of active income continue to be based on the source concept, while passive income be taxed on a residency basis, procedures to prevent avoidance be tightened, greater recognition of foreign tax credits be undertaken, the tax exemption provided to interest flowing to foreign portfolio investors be continued, and a special tax dispensation be introduced to encourage the retention of international headquarters and holding companies.

128. Further interim reports are being drafted covering the introduction of a land tax at the local government level, the tax dispensation of medical aid schemes, friendly societies, and other benefit funds, the taxation of mineral rights, and the taxation of nongovernmental organizations. In addition, a holistic report on the tax system is to be prepared by November 1997. Finally, the government has announced its intention to simplify the Income Tax Act over the next several years, and make greater use of tax reference numbers to minimize tax evasion, including requiring a declaration of good standing to make tender applications for government contracts and to receive government assistance.

South African Revenue Service

129. To address revenue collection problems in recent years—including the build up in tax arrears—and the departure of 13 percent of senior and other staff from tax administration agencies in 1996 alone, in April 1996, the Inland and Customs Departments were merged to form the South African Revenue Service (SARS). The SARS is expected to be made autonomous, within the civil service, with the right to set its own wages and salaries and to finance itself by withholding 1–1½ percent of collections. Further, to rationalize the customs system, the number of international airports that can clear cargo will be reduced from 35 to 10, and the number of border posts will be reduced from 100 to 16; minimum import values are also being imposed.

Restructuring of state assets

130. Progress has been made toward the restructuring of state assets, in accordance with the National Framework Agreement signed between the government and organized labor in January 1996. The program aims at improving competitiveness in firms, promoting human resource development, widening share ownership, and stimulating entrepreneurship within the black community. In late 1996, the government sold six radio stations, raising R 516 million; the proceeds were used to reduce domestic debt. In March 1997, 30 percent of the shares of Telkom was sold to a foreign consortium for R 5.6 billion; of this amount, R 4.4 billion will remain in the company to finance the above-mentioned 2.8 million new connections over the next five-year period in exchange for a five-year exclusivity (monopoly) period; the balance is to be used to reduce central government debt. A further 10 percent of equity of Telkom is expected to be sold to enhance black empowerment.

131. The government has announced that further sales this year will include Sun Air (a regional carrier) and Aventura (a tourist resort company). Various restructuring options include seeking a strategic partner for the Airports Company and for South African Airways; other plans for Safcol (a state forestry company) and Alexkor (a diamond mining company) are being considered, as is the restructuring of Transnet (a holding company for transportation and communication activities) after the problems associated with its large unfunded pension and medical liabilities are resolved. Finally, Eskom (the electricity company) is to be moved under government ownership (it currently has no shareholders, having been formed by an Act of Parliament), and consolidation of its distribution activities into a limited number of regional utilities is being considered.

Financial management

132. A reform of risk management philosophies and principles for government finances is being implemented so as to strengthen financial practices. All funding activities that are currently performed by the Reserve Bank on behalf of the government are being ring-fenced from its monetary operations, and the Department of Finance will become directly accountable for all management matters over its own debt. Primary dealers in government bonds will be appointed in a phased manner (the number is still to be determined), whereupon the functions of market-making and the selling of bonds will be shifted from the Reserve Bank. The present tap system to market government debt will be replaced with a tender or auction system, along with a variety of other structural reforms covering settlement periods, surveillance, risk management, and capital requirements.

133. In January 1996, the Cabinet endorsed the establishment of a formal cash management system within the Department of Finance to eventually remove overlaps between the Departments of Finance, State Expenditure, and the Reserve Bank in the management of the exchequer balances and other public sector cash reserves. In this context, the management of the tax and loan accounts and of the bank accounts of spending ministries would be transferred to the Department of Finance. Several reforms in cash management have already been implemented. Restrictions on cash-in-hand have been introduced, departmental disbursements are matched closer with actual spending, interest earned on statutory deposits such as the National Housing Fund are now credited to the Treasury instead of the relevant department, and the government is smoothing its debt funding peaks. Accounting standards are also to be improved, as is the management of domestic and foreign debt.

25

The old-age pension pays R 470 per month, and is available to everyone over 65 years of age subject to a simple means test. These payments are often the sole source of income for extended families.

26

Statistics that classify students by race are no longer collected.

27

The new Constitution specifies that conditions of service for national and provincial employees will be legislated at the national level, although provincial governments retain the right to hire and fire.