Economy On A Tightrope

GREGORY McGUIRE Sounds A Warning on Budget 2012

Winston Dookeran

It is amazing how quickly the post budget excitement has evaporated. The Finance Minister’s presentation on October 10th 2011, was supposed to be a good news Budget. Its carefully chosen theme “From Steady Foundation to Economic Transfor­mation”, was a promise of better days ahead. Further, for now, the Minister proffered “no new taxes.” But why hasn’t there been a sustained sense of hope over the country? Why hasn’t business confidence returned, notwithstanding the State of Emergency? Might it be because citizens, from the man in the street to the local or foreign investor, remain unconvinced about the prospects for the economy in the short and long term?
The reality is that a budget of TT$54 billion, the highest on record, at a time of considerable uncertainty over revenue flows, has cast serious doubt about the prospects for an economic turnaround. If anything, the Budgetary proposals seem to have placed the economy on the proverbial tightrope with little margin for error.
In his pre-budget discussions, the Finance Minister indicated that the 2012 Budget would focus on three imperatives: restoring fiscal balance, addressing social dislocation and fostering sustainable economic transformation. I wish to focus on the challenge of restoring the fiscal balance. In a previous column, (T&T Review, September 2011) I indicated that some tough decisions would be necessary in order to meet the goal of financial sustainability. I called for action on three fronts: improvements in tax administration, reduction in subsidies and mitigation of corruption. Far from achieving fiscal balance, the Finance Minister will incur a projected fiscal deficit of $7.3 billion, by increasing expenditure by a further 3.2 per cent to a record $54.6 billion. In the two budgets presided over by Mr. Dookeran, actual and planned expenditure has grown by an average of 8 per cent annually, a rate on par with that of the Manning regime over the period 2006-10. Having criticized Manning for excessive spending , the PP Government has come to the party with its own ban, singing and dancing to the same symphony of spend, spend, spend.
We can all acknowledge that a fiscal deficit is not by itself wrong. The value of deficit spending depends on the target of the incremental expenditure and the assumptions underlying the revenue side of the equation . If the deficit goes towards consumption rather than development/investment expenditure, then the economy is likely to be worse off in the event of a continuing shortfall in revenue. The efficacy of Mr. Dookeran’s choice of pursuing deficit spending may be judged by the direction of the expenditure. The data show that development expenditure growth of just 2 per cent on last year’s spend, while the outlay on Transfers and Subsidies has grown again by 9 .5 percent. Very much like his predecessors, Mr. Dookeran seems to have given preference to a continuation of the status quo with respect to spending patterns. Sooner or later a Government will find itself in the situation where there will be no choice but to reduce the level of transfers and subsidies which has climbed from 25.2 per cent of Government expenditure in 2001 to 56.3 per cent in 2011 and at best , remains at that level in 2012. One would have anticipated a major push towards reducing transfers to state enterprises and reducing or capping of subsidies on fuel, water and electricity. But the response was mild.

Once again there are plans to increase water rates; time will tell about whether these plans will materialize. However, the larger problem of fuels and electricity subsidies remain. Wary of possible negative socio-economic and political consequences of subsidy removal, the Government continues to shy away from tough decisions. Instead, it continues to pin its hopes on the CNG initiative. History will show a strong resistance on the part of motorists worldwide to convert vehicles to CNG in the absence of a price/cost driver. At current prices of diesel and regular gasoline, conversion to CNG is not attractive to motorists even with a much lower CNG price.
It is worth reiterating that fuel subsidies lead to waste, inefficient choices, increased carbon emissions, traffic congestion, under-utilized public transport capacity and loss of productivity. The economy will continue to incur these direct and indirect losses until such time as price signals are used to stimulate change in consumption habits. My recommendation is that the Government should begin to wean the population away from the subsidies on fuels and water. It should begin with a cap on the subsidy at the Budgeted price of oil and should be lowered by 5 to 10 per cent each year. Simultaneously, the Government should redouble efforts to provide alternative means of transportation . In this regard it was heartening to hear the Minister’s announcement about the proposed rapid bus system
The risks in deficit spending also come from the revenue side. The Government has based its revenue on three major assumptions: an oil price of US$75 per barrel, a netback gas price of $2.75 /mmbtu and GDP growth of 1.7 per cent for the year. The Finance Minister never mentions it but an important factor in the determination of Government energy sector revenue is output of oil and gas. The Minister’s revenue projections may be challenged on several grounds. Energy sector revenues for 2012 are projected at $18.1 billion the same level as in 2011. However, oil market conditions suggest that both oil and gas prices will be lower in 2012 that in 2011, partly as a result of the sluggish economic growth and partly due to increased supply of natural gas on the international markets, the delinking of gas from oil and the narrowing of the gap between US prices and those in the Europe and the Far East.
Moreover, the Minster himself states that “ since 2006 we have lost 30 per cent in crude oil and condensate output”. It was surprising that there was nothing in the Budget that appeared to target the increase in oil production on land or shallow marine. The measures announced i.e, removal on VAT on imports of drilling equipment etc. are aimed at the offshore environment and basically at avoiding an unnecessary cash transfer. But the Budget is silent on what is to happen with respect to Petrotrin and or its land acreage. A proposed refinery up-grade project should give renewed hope to the oil refining sector. In addition, the Budget listed, in familiar fashion, several downstream possibilities in the natural gas sector. However, none of these new projects are scheduled to come on stream within the next year. As a result output from natural gas is likely to remain flat. This means that both streams of revenue are very dependent on the price forecast, which itself seems optimistic at best. So too are the Minister’s non-energy revenue projections. In the last fiscal year, Government had the benefit of an unexpected revenue inflow from taxpayers taking advantage of the tax amnesty to pay outstanding taxes. This measure yielded an estimated $1.7 billion in additional revenue. These are not revenues that will be forthcoming in 2012, yet the forecast for non-energy revenues remains the same as in 2011- $28.9 billion.
There are two important macro-economic implications of Mr. Dookeran’s approach to fiscal sustainability. The first is that because Mr. Dookeran elects to be overly optimistic in his revenue projections, the fiscal package becomes highly vulnerable to downside risks. Consider the following scenarios. A further 10 per cent fall in oil production will result in a loss of between $400-500 million. If realized prices of oil decline by a similar 10 per cent the fall in revenue could be in the range of $800 to 900 million. Similarly, a 10 per cent lower gas price is projected to leave another $900 to $1,000 million revenue shortfall. The confluence of all three events, which is not improbable, could mean a catastrophic loss of between $1.8 and $2.4 billion, which would bring the projected deficit to around $9 billion- or 6.1 per cent of GDP. Since such a revenue shortfall would be below the threshold that allows the Finance Minister to access the Heritage and Stabilization Fund, Mr. Dookeran will have to either cut planned expenditure or borrow to finance the bourgeoning deficit.
Contrary to the principles espoused in the PP manifesto, Mr. Dookeran’s approach to fiscal responsibility has not demonstrated an understanding of the importance of saving, either for future generations or rainy days. In his two fiscal budgets presented thus far, the Finance Minister has made no provision to the Heritage and Stabilization Fund. During the last fiscal year, when rising prices suggested that actual energy sector revenues would have exceeded budgeted revenues and allowed deposits to the HSF, Mr. Dookeran took the unprecedented step of increasing the budgeted prices so as to avoid making any deposits to the Fund.

Given the optimistic prices selected for the current fiscal package, it is highly unlikely that any deposits will be made to the Fund for a second straight year. The HSF comes up for review in April 2012; the public would hope that changes are made in the rules of accumulation to minimize manipulation by any Minister of Finance and to ensure that at least each year some portion of income from the patrimony is saved for future generations.
In his Budget 2012, the Finance Minister set out, avowedly, to restore fiscal balance. However in pursuit of short term political ends, the Minister has elected to impose “ no new taxes”, but has increased social expenditure, incurred a large fiscal deficit, increased borrowing, increased exposure to downside risks, and made zero provision for savings. The fiscal balance and by extension the wider economy is now highly vulnerable to external shocks which if it does happen would result in either increased borrowing or expenditure cuts with the resultant increase in unemployment. Even if downside scenarios do not materialize, the distribution of planned expenditure is weighted towards consumption rather than investment and seems unlikely to foster a return to growth. It might well be a case of too much risk with too little prospect for reward.

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