Wednesday, November 01, 2006

Government revenues and corporate earnings

The fiscal numbers for the six-months to September 2006 are out, and in my opinion there are no surprises. My own view, which I had written and commented on, is that the $219.2 billion revenue targets are going to be difficult to achieve, given the past performance in the economy and the fact that there was no fundamental change in our economic arrangements.

The September numbers show that revenues are some $2.7 billion behind budget, driven by tax revenues underperforming budget by the same amount. The forecast is for tax revenues for the last six months to be higher than the first six-month period, with tax revenues projected to be $18.0 billion, $17.4 billion, and $26.3 billion in December, January and March respectively. This in my opinion is going to be difficult to achieve, compounded by revenues being behind already.

My reasons for saying this are what I have always been saying. The cement crisis had a significant effect on the economy and corporate earnings, tax collections in the first six months was biased by cash accounting and the collection of arrears, and the economy was not capable of growing at rates of 3% based on the arrangements at the time. I believe, however, that the changing economic climate will see a fundamental shift in the way we produce and will see improvements in real investments, driven primarily by agriculture and tourism. This will be the catalyst for real growth to take place at 3% and more in the future, but the effect on the current fiscal year will not be fully felt.

Fragile economy
With that said though, the economy is in a fragile state and any disruptions caused by (i) an upsurge in crime; or (ii) irresponsible fiscal spending can once again change our course. It is therefore going to be very important that the upcoming election, and the desire to win, is not given primacy over our economic arrangements.

As it relates to current fiscal year revenues, instead of the $219.2 billion projected, we may see actual revenues being achieved between $210 billion to $215 billion for the year. Revenue projections will be adversely affected by the following lines:

- Profits taxes from companies, projected at $20.1 billion for the year, are currently $576 million behind budget, and will continue to be marginally behind budget given the downturn in corporate earnings. This line may end up being $1.1 billion behind budget for the year;


- PAYE, projected at $43.4 billion for the year, is currently $1.5 billion behind budget. With the recent and expected lay offs from companies restructuring to adapt to the changing economic environment, we can expect that this line will under perform, and may come in at $3.5 billion under budget for the year;


- Tax on interest, projected at $13.0 billion for the year, is currently $1.3 billion ahead of budget. In September 2006 this line was over $800 million behind budget because of refund payments to pensions, which are expected to continue into the final six months. This line may come in on target, as pension payments reduces the surplus; and


- Consumption taxes (GCT and SCT) are currently $1.2 billion behind budget. These have been affected by the reduced consumption caused by the cement issue, which has seen some resolution. This will continue to be affected by the corporate restructurings, however, and may come in $2 billion behind budget.

Based on these lines we could see total revenues coming in at between $6 billion to $7 billion behind budget, resulting in the $210 billion to $215 billion range.

With that said, however, the government should easily meet its fiscal target by continuing to spend less than budgeted on programmes, wages and salaries, and capital projects. Interest expenditure will continue to be higher than budgeted, as loans have been higher than projected. The result of this expenditure savings, of course will be that less monies will be available for social programmes, public sector workers will continue to hold strain, and improvements in the capital infrastructure generally, and for schools and the police in particular, may be delayed. It is obvious, however, that the government is committed to maintaining fiscal discipline, and this is the reason for the ability to reduce interest rates and force a shift to real investments in the economy.

Revenue performance
This underperformance in revenues is to be expected given the corporate results over the last six months. This may continue until the end of the calendar year, after which I expect that we will start to see an upturn in corporate activity, as (i) lower interest rates, coupled with the recent lay offs, means that more entrepreneurial activity will take place; (ii) disposable income increases with an upswing in construction, with the return of cement and projects continue; (iii) corporate earnings come off the lows they have been experiencing, as the restructuring initiatives start to take effect; and (iv) world cup 2007 approaches. This of course is dependent on ensuring that fiscal spending remains responsible and confidence is not reversed by virtue of factors such as crime. It is therefore very important that good governance practices are adhered to.

The situation, therefore, is that the economy is at a cross roads. If we maintain control of the social conditions and continue to improve the investment climate then we will see more private investments taking place, and more importantly from small local entrepreneurs. The continued reduction in interest rates will have a positive effect on the real economy and will be a cornerstone to the turnaround in our economic fortunes. Over the next three to six months companies will continue to see the benefits of their restructuring effort, and corporate earnings will begin to increase, resulting in greater government revenues. The real benefit for government revenues will fall into the next fiscal year, however.

The expectation, therefore, is that if we continue on our current path, and not allow political euphoria to undermine our efforts, then we could see growth in excess of 3% next year, but there is a slim chance of achieving that this year. In any event this adjustment is necessary and the important thing is that there is improvement.

It remains a concern that net loan receipts are $20 billion higher than projected. The question I continue to ask is, if we are within our fiscal target then what is the need for the greater than projected loan receipts? With a lower than projected fiscal deficit we should be expecting to see a lower loan receipts instead. This is important as a higher than projected net loan receipts means that interest payments will continue to be greater than budgeted. If we are to remove our fiscal deficit then it is important that we also seek to reduce interest payments, which is a significant portion of our expenditure (40%).


Going forward then revenues is not expected to surpass expectations, especially given current corporate earnings. The fiscal targets will be met, however, by suppressing expenditure. As the fiscal deficit reduces this will allow for further reductions in interest rates, spurring further economic growth. Again I repeat, however, that good governance is going to be essential going forward.

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