Given the enormous importance of the annual budget, I decided to forgo a blog this week and replace it with commentary from the investment team. This is a copy of our weekly market mail. If you have any questions, please don‚t hesitate to ask.

Regards

Albert Botha – Atlantic Asset Management

Dear Investor

When the Greek Prime Minister admits: ‚We are the weak link in the euro zone‚Ķ‚Äù you know that the problem of denial has finally been confronted. It was refreshing too, to hear him say that it is time for Greece, like other European countries, to take ‚brave decisions‚Äù and therefore amongst other things, they would be raising the retirement age from 61 to 63. Also, no state workers would receive wage increases this year. That then would probably encompass the average Greek worker‚s lot in life at the moment. (Did we mention that the public sector forms 40% of GDP in Greece?).

So on to South Africa‚s Budget ‚ the first presented under Finance Minister Pravin Gordhan. How different things would appear to be in comparison to Greece. The oozing impression from the South African Budget is that things are under control. (Well, from a fiscal perspective anyway!) That gunpowder of the current set of global crises, debt, is what makes the difference: Greece‚s public debt to GDP ratio stands at roughly 110% of GDP (and counting). South Africa by contrast, stands at 23%, and expected to increase and stabilise at around 40% in 3 years time. What a difference that makes in terms of policy flexibility. This is not to say that we are without our problems, and it is precisely because of the policy challenges that we face that we need to have policy flexibility. So, from that perspective it is heartening to see that despite all the pressure from various fringe sources, the fiscal policy-makers persist again in following a pragmatic non-populist approach. This can only bode well for the future.

From a broader perspective though, if we compare local currency yields, we can stand amazed ‚ Greece‚s 10 year yields stand at 6.4%, while South Africa‚s stands at a tad over 9%. Sounds like a bargain then? Er, not so much if you consider our inflation rate comparison ‚ ours is expected to average 5.8% over the next year, while Greece‚s will be around 3%. Hang on, what was all that pre-Budget noise about scrapping the Inflation Target in South Africa, and sacrificing inflation for growth? Thankfully, the South Africa Finance Minister chose not to listen to the yapping dogs. Or were they goats?

**(Greek) tragedy : Derived from tragos = ‚goat‚Äù and aeidein = ‚to sing‚Äù. Analysts postulate that these origins date back to a time in which a chorus sang and danced prior to the animal‚s ritual sacrifice.

Weekly Compass Points

This week, our Weekly Commentary focuses on the key takes from the Budget, as one of the crucial pieces of the puzzle that remains to be pieced together over the next couple of weeks. Too much dust still needs to settle before we can all make clear decisions on the longer-term implications of this Budget, while we will also be bombarded with further risks over the next 6 weeks, starting with today‚s Industrial Policy release, GDP statistics and the NERSA decision on Eskom‚s tariff increase next week, the usual month-end macro data, the BER inflation expectations survey and the important MPC meeting next month.

Budget Sound Bites

(Emphases are our own)

For those readers interested this summary is around 15% of the overall speech…

Our people need hope. Our people want government to lead. We will lead.
Our people want action on jobs, growth and poverty. We must build a new common purpose so that we can use all of our talents, skills and resources to tackle our economic and social challenges.
A new engagement between government, the business sector and organised labour is being forged, through which we will mobilise our creativity, our determination, our sheer grit ‚ to build a durable, developmental, just and prosperous nation.
So we have to do things differently ‚ we have to act now to strengthen the institutions through which public services are delivered, and to transform the structure of our economy, so that all South Africans can share in the opportunities that our country offers.
Our growth expectation for 2010 is now 2.3 per cent, rising to 3.6 per cent by 2012.

…it is time to put aside our differences and recognise that we have a shared vision of a new economy.

This budget outlines several aspects of a new growth path for our country:
1. A concerted effort to reduce joblessness among young people
2. Support for labour-intensive industries through industrial policy interventions, skills development, public employment programmes and a rural development strategy.
3. Sustaining high levels of public and private investment and raising our savings level.
4. Improving the performance and effectiveness of the state, especially the provision of quality education and training at all levels.
6. Keeping inflation low, striving for a stable and competitive exchange rate, and providing a buffer against global volatility.

Industrial policy

Turning an economy around and achieving the kind of transformation required to draw in the millions of unemployed people into the economy is not an easy task. We must be honest; it will not happen tomorrow morning. It will take time and forward-looking policies that are effectively implemented. It will take hard work. We must have the courage to make difficult choices about investment priorities, industrial policy options, spending priorities, technology alternatives and trade strategies.

As required by the Constitution, the Bank should pursue its mandate independently and without fear, favour or prejudice. The Governor and I will consult regularly to ensure that South Africa is prepared to respond with agility and flexibility to changing economic circumstances.
A credible monetary policy framework that focuses on managing inflation is crucial to reducing long term borrowing costs and providing confidence about the future.

Mister Speaker, I wish to confirm that the Reserve Bank will continue to pursue a target for CPI inflation of 3 to 6 per cent. Governor Marcus and I have agreed that monetary policy should be conducted in a consistent and transparent manner within a flexible inflation targeting framework. The role of the Bank in maintaining financial stability will also be enhanced.
Improved communication with the public about the role of monetary policy in supporting growth will increase the effectiveness of the Bank in achieving its mandate. The Governor and I agree that ongoing assessment, discussion and commentary about our monetary policy by analysts, interested members of the public, interest groups, and the broader research community, is constructive for the emergence of a social consensus in this area over the longer-term.

The cost of higher borrowing is, however, greater expenditure on interest. Our public debt is expected to rise from 23 per cent of GDP in 2008/09 to about 40 per cent in 2013, and will only stabilise in 2015. Higher government borrowing is only a temporary solution to our economic challenges.

To ensure that future growth and public service delivery are not compromised by unchecked rises in interest costs, our medium term fiscal framework allows for a gradual reduction in the budget deficit.

Given the gap between spending and revenue, alongside efforts to curb spending growth, government requires more tax revenue.
Notwithstanding this, we may have to raise taxes in future to fund our public spending commitments.
Furthermore, it is proposed to increase taxes on fuel by 25.5 cents a litre. This includes a 7.5 cents a litre increase to contribute to the funding of a new multiproduct petroleum pipeline between Durban and Gauteng, and an increase of 8 cents a litre in the road accident fund levy.

Real growth in public spending over the next three years is about 2 per cent a year.
This is lower than the rapid growth in public spending over the previous three years, but it still provides for substantial increases in our key spending programmes.

The local government equitable share receives a further R6.7 billion to support municipalities to cushion poor households for the rising cost of electricity and water.
An additional R2.5 billion goes to the Municipal Infrastructure Grant. Total allocations to municipalities rise from R55 billion in 2009/10 to R78 billion in 2012/13. We are mindful of the fact that even though transfers to municipalities have increased strongly over the past five years, service delivery problems persist. We are working with the Minister of Cooperative Governance and Traditional Affairs to resolve these problems, to improve financial management and to ensure that higher spending allocations translate into real improvements in people‚s lives.

Over the 2009-2014 period, the second phase of the expanded public works programme aims to create 4.5 million short-term job opportunities.

Mister Speaker, the savings exercise that we have undertaken must be seen as a first step to get better value for money.

Jointly with Minister Chabane‚s new department, we will be conducting comprehensive evaluations of several key spending areas this year with a view to eliminating ineffective programmes and generally improving value for money. Furthermore, we will investigate the possibility of rationalising some of our entities and agencies to see if we can deliver the same service at a lower cost.

Including provisions in this budget, we have made allowance for the recapitalisation of the Land Bank to the value R2.5 billion. A guarantee of R15.2 billion has been approved for the Development Bank of Southern Africa, enabling it to extend capital to poorer municipalities for infrastructure projects. The Industrial Development Corporation is well capitalized and will continue to play a key role in implementing government‚s Industrial Policy Action Plan.

Public sector remuneration

Mister Speaker, the 2009 round of salary increases has placed immense pressure on the budget. Including the very necessary adjustment to the salaries of professionals, the wage bill has almost doubled in five years. Now that a major revision to public service remuneration is behind us, it will be necessary to moderate salary increases going forward. This is required to ensure that funds are also available for growth in public service employment and so that spending on school books, hospital building and maintenance of infrastructure is not compromised.

A major site of both wastage and inefficiency is in our procurement system.

Mister Speaker, corruption is an ever-present threat to our ambitions. All South Africans must constantly and consciously work to root out this cancer. If we are to address this scourge, we need improved management capability, governance, enforcement, and oversight in government, and in the business sector. Poorly managed tender processes are all too often open to such abuse. Greater transparency and accountability in procurement systems will therefore be a key focus of reform in the period ahead.

South Africa was spared from the worst of the crisis. While some of the largest global banks were forced to receive bail-outs, our financial institutions did not require such support. I wish to commend the Reserve Bank for the vital role played in supervising our banking sector. I also want to acknowledge the governance and risk management systems of our banks, which proved effective during the global crisis.

Although our institutions have proved to be robust, we must not be complacent. I want to highlight several new initiatives to improve our regulatory system.
We are reviewing our adherence to global regulatory standards in banking, insurance and securities markets.
Various changes to the Basel II framework will be effected once the impact assessment is completed.

So there you have it ‚ straight from the horse‚s mouth. This is certainly not stirring stuff, but rather the voice of a careful pragmatist who has laid the foundations for a new path. In his speech, Minister Gordhan used the word ‚new‚Äù 27 times. It should be a pointer towards the changes that lie ahead for our economy and we underestimate that meaning at our own peril.

Atlantic Investment Team