Does fiscal surplus really matter?

Source: Does fiscal surplus really matter? – NewsDay Zimbabwe May 16, 2019

Guest column: Respect Gwenzi

Zimbabwe is presently enjoying a short term stint of month-on-month fiscal surpluses stretching four months, that is a period between December 2018 and March 2019. This is a breakaway performance from a protracted budgetary deficit position over the last, at least, five years.

In the respective years between 2016 and 2017, the budget deficits came in at $1,5 billion each year before swelling to about $2,8 billion in 2018. This unsustainable level of deficit in 2018 equated to 12% of the gross domestic product. The desired and managed deficit threshold would range between 1% and 5%. It has been widely agreed that deficits either on budget or current account need to be managed to stem a deepening economic crisis in Zimbabwe. The undesirability of deficits emerge from the realisation that they come at a steep cost, mainly in the form of borrowings.

Having re-engineered the fiscal leg of the economy in matters that will be discussed in this piece, government has reversed, over the last four months, the deficit position, posting an average surplus of $100 million a month, according to the Finance minister. The desired outcome is to constrain money supply growth and improve forex availability, while simultaneously taming inflation and managing economic growth levels.

Unrestricted money supply growth has the effect of spurring short-term demand, resulting in an economy overheating. It also has an impact on national debt levels and the side effects of private sector growth constraint as resources are channelled towards government needs.

Over the last three months, government, its cheerleaders and commentators have gone into overdrive, prematurely celebrating success in turning around the economy or at least in realigning the fiscus. Adherence to basic economic principles would discredit this fallacy or rather fantasy advanced by this viewpoint of ready consolidation success. In matters of economics, if one misses the principle of opportunity cost and fails to adhere to cost benefit analysis in scenario evaluation, oftentimes the outcome is disappointing, if not delusional.

Government’s stance in realigning the fiscus has been that of enhancing revenue and not cost containment. Cost containment, which entails reforming parastatals to increase efficiency and root out corruption, disposals and privatisation of some entities and re-evaluation of the civil service, rationalisation and wage cuts, typically brings sustainable positive results with minimal downside.

It, however, comes at a huge political cost of patronage loss and cronyism, and may actually result in loss of political power. Although gestures of reforms in this regard have been tabled and in some instances are being expedited, the gap remains wide, given the gravity of economic mess Zimbabwe is in.

The clear path taken by President Emmerson Mnangagwa’s administration is that of massive contractionary fiscal policy involving high taxation and widening of the tax base, typical of the failed Economic Structural Adjustment Programme, in an exercise dubbed as austerity. Treasury coffers have since been boosted by the 2% intermediated money transfer tax, an increase on fuel excise duty, inflated value added tax arising from the surging prices of goods in the economy. This buffer to the fiscus has cosmetically positioned the new administration and notably the Treasury duo, as champions of austerity and economic reformation, even without them scratching their heads for a solution. These short term gains will sure be wiped off by cyclone inflation, which is clearly wreaking havoc in the economy as rounds of price blitzes take the toll on the economy.

The danger of pursuing a contractionary policy infested with tax increases is that costs typically re-rate upwards and producers pass on the cost to the consumer, thus eventually constraining demand. Likewise, the objective of producers becomes that of defending margins as volumes come off and this means increasing prices. This dearth in production gradually results in constrained economic growth and a simultaneous inflation, a phenomenon known as stagflation. Inflation is further propelled by the fragility in currency, given that the interbank market is yet to find its equilibrium. Reliance on imports for finished goods as well as raw material estimated at 40% exposes most cost functions to the exchange rate and ultimately denotes a forex-pegged product pricing to counter exchange losses. Although a weaker exchange rate would make local produce relatively cheaper to the region, industry is not readily equipped to exploit this gap to counter the erosion in local demand.

So, of course, government has enjoyed a surplus over the last four months, but these gains are not sustainable. In fact, they have a downside which will play catch-up. This is why it is important to point out the expenditure performance of government relative to budget and not to revenue.

In succeeding months, we will witness the gradual closing in of the fiscal surplus as costs catch up. Government has already offered an unbudgeted for 28% increase in civil service wages to address rising prices, and this will be reflected in April numbers.

In April an unbudgeted for 38% subsidy was offered to farmers as a consequence of rising prices, with respect to the 2019 harvest, and this too will impact expenditure. On the revenue side, as austerity entrenches, demand will significantly come down, and this has a run on revenue collections, further narrowing and eventually reversing the surplus gap.

 Respect Gwenzi is the lead analyst and managing director at research firm, Equity Axis