Let’s avoid budget deficits

11 Dec, 2016 - 00:12 0 Views
Let’s avoid budget deficits

The Sunday Mail

Clemence Machadu Insight  —
Howdy folks! The 2017 National Budget Statement presented by Finance and Economic Development Minister Patrick Chinamasa has shown unsustainable revenue and expenditure patterns that should be decisively dealt with in future to ensure the economy performs well.

Minister Chinamasa said a budget deficit of US$1,18 billion was incurred, against a planned deficit of US$150 million. This year’s fiscal deficit represents 8 percent of GDP, and that is unsustainable. A deficit threshold of 3 percent of GDP is generally acceptable and regarded as sustainable.

But it is important to understand what a fiscal deficit is before going into its impact. A deficit occurs when incurred Government expenditure exceeds revenue. Since expenditure has already been incurred, it becomes a debt that has to be paid somehow.

This year’s unsustainable financing gap of US$1,18 billion arose from under-performance in revenue which is now projected at US$3,53 billion; against excessive anticipated expenditures of US$4,59 billion.

It is argued that if a deficit arises as a result of more Government expenditure towards infrastructural projects or loans to productive sectors, it’s a good thing as it increases production.

But in our case, much of the additional expenditure was channelled towards consumptive spending. Some US$253,5 million was used for drought-related grain importation for vulnerable communities, while US$101 was channelled towards debt servicing.

These two activities, although necessary, do not increase national production. About US$119 million of that additional expenditure was used to meet the December 2015 salary payment arrears for civil servants.

At least this amount increased demand in the economy. But the real impact of a budget deficit has to be understood from different perspectives. Four scenarios will be considered here.

Increase in borrowing
A budget deficit implies Government has to resort to the domestic market to raise money by issuing bonds as most bilateral partners do not provide budgetary support, while most multilateral funders cannot support us until we clear our arrears.

The domestic market is the only option left. This, therefore, increases the domestic debt and as excessive debt continues to pile up, a vicious cycle is created. As at October 31, 2016, domestic debt stood at US$3,7 billion; representing 26 percent of GDP.

Competing with private sector
By going to the domestic market to raise money, Government will also be competing with private sector players requiring the same resources.

Government bonds are usually regarded as very safe investments, so they tend to have higher demand. This reduces the pool of available funds to be lent out or invested in other businesses.

For example, an individual who lends US$100 000 to Government cannot use the same amount to buy shares on the stock exchange. This clearly shows that budget deficits can reduce potential capital stock in the economy.

Interest rates
Since Government has already issued a lot of bonds and Treasury bills, supply has somehow outstripped demand for the instruments. If Government is to issue more bonds, it means it will have to offer a higher interest rate to attract buyers.

However, that can also affect the financial sector as private players intending to raise capital will now be compelled to compete with that interest rate.

If Government bonds are paying 5 percent interest, it means other private players competing must offer a higher rate to attract buyers away from Government instruments.

This might force banks to raise their charges and it also applies upward pressure on lending rates that are already usurious. This is why Minister Chinamasa said in his budget statement, “Increased recourse to the domestic financial system for financing of the budget deficit would become destabilising as cash and cash equivalents available to Government force larger reliance on financing modalities that contribute to significant financial sector risks.

“This is with regard to both financial sector capacity to finance productive sector business activities as well as the financial health of domestic banking institutions. This is moreso in view of the quantum of Treasury bills already issued.”

Crowding out effect
A budget deficit can cause Government to increase its reliance on borrowing from foreign sources in future. As this happens, future budgets can place more emphasis on loan repayments and less emphasis on savings and investment.

Already, about US$100 million went to debt-servicing in 2016 and US$180 million was allocated towards debt-servicing under the 2017 National Budget. While the present generation may benefit from borrowing, future generations will pay the price.

Going forward, it is important for Government to plan effectively and stick to the planned expenditure while, by all means, avoiding the temptation of crossing the line.
Later folks!

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