What to do: Budget deficit is biggest elephant in the room

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CZI president Sifelani Jabangwe

Kudzanai Sharara Taking Stock
The Confederation of Zimbabwe Industries this week held its 2018 Economic Outlook Symposium that sought to map the way forward on how businesses can tackle economic challenges that they are likely to face in 2018.

In his opening remarks, CZI president Sifelani Jabangwe said the platform was meant to help leaders plan for the year ahead as well as help navigate challenges they are likely to face.

One feature that kept coming up for discussion was that of the country’s perennial problem of the ever increasing budget deficit. The first presenter, James Wadi, group economist at BancABC was the first to raise concern over the wide disparity between the country’s original budget deficits and the actual out-turn. From 2015 to 2017, the Government has been running a budget deficit that is more than what would have been envisaged in the original budget.

While running a budget deficit is not peculiar to Zimbabwe, the situation is, however, different as Government has failed to control the country’s overall spend.

The variance between the budgeted deficit and the actual out-turn has been too big as shown in 2016 when Government budgeted for a $150 million deficit but ended the year sitting on a deficit of $1,4 billion. The gap was also evident and even bigger in 2017 where Government budgeted for a $400 million deficit but ended the year with a deficit of $2 billion.

Worse is expected in 2018 where Government has already budgeted for a $672 million budget deficit. If the past trend is to continue, then the gap will be much higher especially considering that there are now high chances that the country might be facing a drought, which might result in increased and unbudgeted Government spending.

As said earlier, running a budget deficit is not peculiar to Zimbabwe, but what makes Zimbabwe’s situation a bit more complicated is that the country’s options in trying to fund the deficit are very limited.

Over the years’ Government has resorted to borrowing from the local market to fund the deficit. This has resulted in the country’s domestic debt levels ballooning to unsustainable levels although Government insists its manageable. Apart from the debt being untenable, borrowings through issuance of Treasury Bills have also posed serious threats to the financial sector, where the ratio of liquid cash — nostro plus foreign notes and coins — is significantly lower than the bank deposits. The result has been a major strain in the economy’s ability to make payments.

Increased government borrowing to fund the deficit might also result in a decrease in the size of the private sector, through the crowding out effect. With most banks buying treasury bills, they end up with less money to invest in private sector projects and this will become an albatross to the economy.

The Zimbabwean situation might be slightly different as local banks are sitting on huge balances with the average loan to deposit ratio below optimal levels.

A budget deficit also implies Government is not living within its means and is spending more than what it is generating through taxes. The result will be a higher aggregate demand and this may cause higher inflation, something we are beginning to see with inflation now above the year’s target of 3 percent.

The other challenge with Zimbabwe’s budget deficit is that the spending is largely on recurrent expenditure with little going into infrastructure. Given that the country is currently a net importer, it means the spending will have little impact to economic growth and will not dent the deficit.

The big question however is how Government should tackle this challenge which was described by Economist, Professor Ashok Chakravati as the elephant in the room.

While other countries can resort to cutting interest rates in an effort to boost spending, the RBZ can only use moral suasion with banks reluctant to cut back on interest rates.

This means it will be difficult for government to deal with the budget deficit through growing the economy — a result of low interest rates.

High interest rates means private sector players and individuals will limit borrowing and in the process aggregate demand will be limited and by extension subdued economic growth.

While other countries can also pursue quantitative easing policies to stimulate economic growth and reduce budget deficits, it’s an option that is not available as the country does not have its own currency, while efforts to use Treasury Bills have been nothing but disastrous for the monetary sector.

If Zimbabwe had its own currency it could have devalued its exchange rate to make sure its products are competitive, but the bond notes, the closest to a local currency, have been pegged to the US dollar. Therefore, the country will not be able to solve its budget deficit by growing the economy.

Economic players have been calling on government to cut spending to reduce the budget deficit, but this might also not work in our favour as reduced spending might send us back to deflation and lower economic growth. A lot of companies have benefited from increased government spending and have increase output and employment as a result. If Government is to cut back on spending, it might just be a question of replacing one problem with another.

What to do?

Economist John Robertson believes one-way Government can deal with the budget deficit is to generate more taxpayers. This can be done through widening the tax bracket. The IMF has since said the country has the second highest informal sector at approximately 62 percent. The country’s revenues can thus be grown if all economic players play their part in contributing to the country’s fiscus.

Robertson believes Government can generate more taxpayers by encouraging and promoting the creation of more businesses, which would employ more people. He says government has to reduce all the controls that were slowing investment down.

“In the past, Government discouraged new businesses by creating hostile conditions, and these conditions were bad enough to force many existing businesses to shrink or close down. Most of the people they used to employ are now working in other countries and paying taxes to foreign governments. We have to research every possible way to bring back the investors who can create businesses and jobs,” said Robertson.

Another option could be internal devaluation through the reduction in the costs of doing business. Government has since embarked on this path with fuel prices having been reduced by 3 percent. Hope is that whatever Government has lost in the form of excise duty will be surpassed by increased corporate taxes and value added tax if consumers are to spend more following the expected cut back on prices of basic commodities.

Another economist Muhammad Umar concurred with Robertson saying the budget deficit could be avoided by promoting economic growth which will widen the fiscus base while maintaining expenditure at current levels.

“Secondly all these are short term knee jerk reactions which have unintended negative consequences across the board. If we curb government spending it will curtail economic growth and GDP will be imperiously affected.

Muhammad believes “there should be austerity in prosperity rather than in the periods of budget deficit and fiscal deficits primarily to instill economy wide confidence.”

“Inflationary pressures born of budget deficits need to be addressed since they have an uncanny manner of inflating such deficits. Thus sustainable monetary policies with a growth orientation and demand side focus will foster an environment of curtailing inflationary pressure.”

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