VZCZCXRO2917
RR RUEHDU RUEHJO RUEHMR
DE RUEHSA #4508/01 3131329
ZNR UUUUU ZZH
R 091329Z NOV 05
FM AMEMBASSY PRETORIA
TO RUEHC/SECSTATE WASHDC 9949
RUCPCIM/CIMS NTDB WASHDC
INFO RUCNSAD/SOUTHERN AFRICAN DEVELOPMENT COMMUNITY
RUCPDC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 03 PRETORIA 004508 
 
SIPDIS 
 
SENSITIVE 
 
SIPDIS 
 
DEPT FOR AF/S/MTABLER-STONE; AF/EPS; EB/IFD/OMA 
USDOC FOR 4510/ITA/MAC/AME/OA/JDIEMOND 
TREASURY FOR OAISA/JRALYEA/BCUSHMAN 
USTR FOR PCOLEMAN 
 
E.O. 12958: N/A 
TAGS: ECON EINV EFIN ETRD BEXP KTDB PGOV SF
SUBJECT: MID TERM BUDGET STATEMENT PREPARES FOR 6% GROWTH 
 
(U)  This cable is Sensitive but Unclassified.  Not for 
Internet Distribution 
 
¶1. (U) Summary.  Finance Minister Trevor Manuel delivered 
his Mid Term Budget Policy statement (MTBPS) with the South 
African economy facing relatively high growth, low 
inflation, improving global markets, and low budget 
deficits.  Manuel's emphasis was on doubling South Africa's 
current long-term average growth from 3% to 6%.  Two major 
themes emerged from the MTBPS:  (1) the government would 
accelerate growth by ramping up public sector investment in 
the nation's infrastructure; and (2) the government would 
reinforce public sector spending on existing social programs 
in health, education and housing.  Manuel did not announce 
any major new tax or expenditure programs, but did recognize 
that better management of welfare programs at both national 
and provincial levels was essential.  Manuel did announce 
additional measures to relax foreign exchange controls.  End 
Summary. 
 
Manuel Cites Favorable Economy 
------------------------------ 
 
¶2.  (U) Finance Minister Trevor Manuel cited low inflation, 
increasing growth, and a much lower fiscal budget deficit as 
South Africa's "sweet spots" during his Mid Term Budget 
Policy statement (MTBPS) address.  He said that South Africa 
must now focus on fixing obstacles to increasing its 3% long- 
term growth to 6%.  By focusing primarily on improving 
infrastructure, education, and housing, the MTBPS reaffirmed 
the importance of developing the economy's supply potential 
to shift the growth trajectory upwards.  South Africa's 
"sweet spots" should continue as the MTBPS forecasted steady 
growth above 4%, low inflation and smaller than expected 
budget deficits for 2006 through 2008.  Forecasted growth in 
2005 was raised to 4.4%, the highest since 1988.  Peaking in 
2006 at 5.2%, targeted consumer price inflation (consumer 
prices excluding mortgage costs) should recede to 4.8% and 
4.5% in 2007 and 2008, respectively.  Thus, inflation should 
remain well within the 3-6% target inflation range during 
the 2005-2008 period. 
 
Budget Deficit Lower than Expected 
---------------------------------- 
 
¶3. (U) Compared to the forecasted 3.1% budget deficit to GDP 
ratio made last February, the budget deficit should be 
significantly smaller, reaching 1% in 2004 and an average 
2.1% over the next three years.  An extra R30 billion ($4.6 
billion using 6.5 rands per dollar) extra in tax revenue 
should be collected this year as compared to forecasted 
amounts.  The Government spent only 46% of its appropriation 
during the first six months of 2005/06, or R4.6 billion 
($700 million).  In the second six months, the public sector 
should step up its spending on transportation and 
electricity infrastructure, as well as low income housing. 
This is part of a push to raise public sector fixed 
investment over the next three years to 6.7% of GDP up from 
its current level of 5.6%. 
 
¶4. (U) Government will also funnel additional resources to 
the provinces and local government.  In 2006/07, provincial 
and local governments should receive 57% and 6% of the 
national government's non-interest government expenditures, 
respectively.  Provinces should receive an additional R30 
billion over the next three years.  Funding for housing and 
transport projects should get R20 billion or 36% of the 
additional planned government expenditures.  For education 
and health, Government will focus on improving the quality 
of services, rather than on expanding their coverage. 
 
No Foreign Funding and Growth Impediments 
----------------------------------------- 
 
¶5.  (U) According to the MTBPS, South Africa's current 
account deficit should remain above its 2005 estimate of 
3.5% for the next three years, reaching 4.1% by 2008.  The 
National Treasury believes that the deficit should be easily 
financed by short-term foreign investment flows, which are 
to some extent tied to the value of the rand.  The National 
Treasury still believes that the country would be better 
served if it could attract higher levels of foreign direct 
investment, but this has not yet materialized.  Net foreign 
 
PRETORIA 00004508  002 OF 003 
 
 
direct investment contributed only 9% to the financial 
account surplus in the first half of 2005.  [Note:  a few 
large British investments announced in 2005 should change 
this view.] 
 
¶6.  Demand for South African goods should improve over the 
next three years.  In 2006, the world economy should grow by 
4.3%.  Although growth in the Euro-zone countries, including 
some of South Africa's major trading partners, will grow 
much slower than the world average, they should grow faster 
in 2006.  In 2005, the Euro-zone countries grew at 1.2% 
compared to 3.5% for the United States.  In 2006, the Euro- 
zone growth should recover in 2006, reaching 2.2%. 
 
¶7. (U) To ease the outward flow of foreign currency, Manuel 
announced the next phase in the gradual relaxation of 
exchange rate controls.  Mutual funds and investment 
companies will be allowed to hold up to 25% of their total 
retail assets in foreign currency investments, up from 20% 
and 15% of assets, respectively.  South African banks will 
be allowed to lend foreign currency denominated instruments 
to South African companies and 3% of their total assets or 
40% of their offshore capital without South African Reserve 
Bank approval.  Manuel announced no changes to exchange 
controls governing individual South Africans. 
 
No Tax Breaks 
------------- 
 
¶8. (U) Other than reforms in the tax treatment of medical 
insurance plans and the introduction a 15% withholding tax 
on foreign entertainers, Manuel made no mention of any other 
tax changes or a reduction in tax rates.  He did mention, 
however, several changes on the revenue side for 2006, the 
most important being the abolition of the Regional Services 
Council (RSC) levies.  The RSC levies consist of a payroll 
and a revenue tax, which together constitute 80% of the 
revenue collected by large urban metropolitan areas.  Manuel 
made no mention of raising any additional taxes to make up 
for the loss of the RSC levies, although likely candidates 
would have been taking a share of the fuel tax, creating a 
new local business tax, and/or transferring more revenue 
from the National Treasury to cities.  Manuel added he would 
announce adjustments to individual tax brackets and other 
changes in February, but gave little detail about how these 
would affect personal or corporate taxes. 
 
¶9. (U) So far, the South African Revenue Service (SARS) has 
collected R21 billion ($3 billion) more than anticipated in 
last year's budget.  Analysts believe that this revenue 
overrun is likely to reach R30 billion ($4.6 billion) by 
year's end.  Local economists have offered several 
explanations for the large discrepancy between the growth in 
tax collections and the growth in GDP, such as improved tax 
collection by SARS, a shift in consumer spending towards 
higher valued goods, or the possibility that GDP growth has 
been underestimated and will have to be revised upward in 
early December.  What is evident is that strong consumer 
spending has driven VAT and customs revenue higher, and that 
both corporate and personal income tax revenue has been 
higher than expected. 
 
Supply Side Emphasis 
-------------------- 
 
¶10. (U) The MTBPS emphasized infrastructure spending, 
improving public services, the provision of better housing, 
and improving job skills as ways to accelerate growth.  Over 
the Mid Term Expenditure Framework (MTEF) period from 2006 
through 2008, government fixed investment spending will grow 
from R18.9 billion ($3 billion) to R39.5 billion ($6 
billion), with the greatest increases seen in low income 
housing, rail transportation, road construction and the 
provision of water services.  The government also wants to 
spend more on public health facilities and education. 
Welfare spending as a percent of total expenditures will 
fall from 19.1% in 2005 to 18.4% in 2008.  Spending on 
education will remain at close to its 2005 share of 21.4% 
throughout the MTEF period. 
 
Comment 
------- 
 
 
PRETORIA 00004508  003 OF 003 
 
 
¶11. (SBU) The MTPBS and subsequent comments by government 
officials stress the importance of infrastructure and 
education in achieving higher growth.  The question is, 
"Will the South African economy deliver the appropriate 
supply response?"  Cement prices have risen considerably 
faster than inflation, and rationing has already been 
reported in the Eastern Cape.  Shortages of engineers and 
skilled labor are repeatedly cited as a constraint on 
growth.  Total investment should reach nearly 18% of GDP in 
2008, still far short of the estimated 25% needed to achieve 
6% real growth.  Large investments in infrastructure by both 
government and state-owned enterprises such as Eskom in 
electricity, Transnet in transportation, and a new national 
water utility should boost the economy and at the same time 
improve basic infrastructure, but they test the supply 
response of an economy already moving at full throttle.  The 
result may only highlight the constraints on growth posed by 
the lack of skilled labor and labor market inflexibilities, 
high transport and communications costs and the extreme lack 
of capacity in government to deliver needed municipal 
programs and services to the very large poor population 
distributed throughout the country. 
 
HARTLEY