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TETRAD – Spot the deliberate mistake(s)

By The Tetrad Group

MARKETS, which look to the annual national budget to provide some indication of economic policy direction, particularly changes in taxation, in the year ahead are likely to find that the

2004 budget statement raises more questions than answers. The unsatisfactory situation, however, is not entirely the minister’s fault.

Eight years ago a decision taken to align the fiscal, with the calendar-year led to the budget presentation being moved from July to near year-end. Whatever theoretical merits were claimed to result from the change, it required the minister to provide an ensuing annual forecast without knowing where the economy actually was when he made it, in practice, to pile guesstimates upon estimates.

With no more than a modicum of administrative competence at his disposal and a little luck – as happened this year- the minister was able to confidently predict that 2004 expenditures would match the original forecast of $8,74 trillion. With a forecast revenue of $7,46 trillion, the deficit exclusive of debt repayment, will be $1,28 trillion, or about 4,9% of the GDP. No GDP figures were given either for 2004 or 2005 but from the projected fiscal outline for next year (revenue $23 trillion, expenditure $27,5 trillion and an unchanged deficit/GDP ratio of 5%), forecast nominal GDP for 2005 comes out at $90 trillion. A return to positive real growth of between 3,5 to 5% is also predicted.

All relatively straightforward so far — or so it might be thought. Things start to fall apart, however, once the figures are subjected to closer scrutiny.

The minister is surely right to describe agriculture as “the backbone of the economy”. How much reliance can be placed, certainly at this stage of the season, upon the projected 28% growth in the volume of agriculture production in 2005, however, is debatable. The current summer season has had a hesitant start and poor rains in November often, although not invariably, presage lower than average seasonal rainfall. The national accounts bear testimony to the very large annual swings, which can occur in the volume of agriculture production due to the fickleness of the climate.

The authorities’ method of dealing with those major forecasting uncertainties has been simply to assume a good, or even “bumper”, summer cropping season. Whatever theoretical satisfaction this may have led to, the official figures show that even a simple assumption of some positive agriculture sector growth would have been correct for only about 60% of the past 20 years.

But the budget’s shortcomings cannot be attributed largely to the problem of anticipating the impact of climatic vagaries. The numbers’ problem may be said to begin with the next year’s $90 trillion GDP guesstimate already noted. Latest available, provisional national accounts suggest that depending upon what price deflator is assumed nominal GDP this year could reach $26 trillion.

This would imply that nominal GDP growth officially forecast for next year is of the order of 240-250%. But the predicted average inflation rate in the budget figures for next year is 100% (January 150% and December 50%). This suggests that to reconcile the two figures real growth would have to be something of the order of 150%, an obviously highly improbable, indeed impossible, outcome.

The only way that the projected GDP, deficit, revenue and expenditure figures can be made compatible with each other is to assume an average annual rate of inflation for 2005 in excess of 240%.

Keen-eyed businessmen will immediately notice that this would sharply conflict not just with the budget indicated average of 100%, but even more so with the graphic representation of an average under 50% inflation rate in the Vision 2007 targets of the October 2004 monetary policy statement.

If, on the other hand, average inflation next year were to fall even just to the budget forecast, the revenue, expenditure and deficit targets would be unattainable without a savage rise in taxation — again the complete opposite of the $5 trillion release to taxpayers the minister has proposed. Faced with imponderables such as these making much sense of the budget numbers become near impossible.

Indeed, the apparent discrepancy between Treasury and Reserve Bank inflation forecast on its own provides heightened uncertainty not just over the likely rate of price rise but about the probable future course of interest and exchange rates — neither accorded serious treatment — given especially the minister’s comment that subsidies — and presumably the current level of quasi fiscal expenditure — are unsustainable.

In the light of these uncertainties the only sensible reaction to the budget’s contents is that all bets for 2005 are definitely off, for the moment at any rate.

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