The proof of Surplus is in the eating

Zimbabwe is currently registering a rare surplus which has been an uncommon feature in much of the previous government’s lifespan under President Robert Mugabe.  Since December 2018, after the government introduced what it dubbed as the austerity for prosperity, which in simple terms are policy measures designed to rebalance the fiscus primarily through taming perennial deficits positions in either fiscus and external trade side, treasury books have shown a consistent fiscal surplus position. The surplus has however become a fault line in the economic discourse on Zimbabwe. 6 months into austerity, there are persuasions on either side for and against, regards whether the fiscal surplus, which was recorded at $443 million for the first quarter of 2019, is an indicator of economic recovery and a conduit for sustainable long term economic recovery. A section of enthusiasts, are riding on the surplus wave and in recent months the IMF as well as respected economists including the Finance Minister have deduced, largely from the surplus in question, that economic fundamentals are now rightly configured and improving and that generally the surplus has been more beneficial than it has been costly to the economy.

On the other end, scepticals and pragmatists alike question the quality of surplus and its implication. Among these are general Zimbabweans, many of whom are reeling in deep poverty levels worsened by the erosion of purchasing power and rampant economic losses much of which intensified from the time austerity was introduced. They are persuaded by the worsening economic plight that the surplus is not real and yet they do not project a light at the end of the tunnel. The country is therefore engaged in a persistent debate on the direction the economy is taking given the variance between the improvements as recorded by Treasury through the communicated surplus and propagated by those who believe in the respective policy measures, and a worsening poverty and deindustrialisation of the economy experienced ever since austerity was promulgated.

In my view, the only significant positive from the obtaining fiscus surplus is that government has managed to reduce its reliance on private sector debt since much of the expenditure now falls within budget, at least for now. The extension in private sector debt through issuance of sovereign securities in the absence of new lines of credit from the international financiers, in years past, had driven government debt levels into unsustainable levels, heightening  fears of financial sector bubble and currency collapse. As at December 2018 the government had a combined debt level of circa $20 billion which was almost 84% of total GDP, with just over 10% of the debt having been borrowed in 2018 alone. Total credit in the economy had spontaneously increased by35% year on year to levels just above $10 billion.  Apart from the diminished ability to repay, by the very act of reckless borrowing over the last 5 years, government effectively contracted a cancer into the monetary system as the accruing interest settlements led to a new form of local money now known as the RTGS$.

So the present surplus diminishes propensity for money supply growth, which spontaneously slows down the rate of growth in local RTGS$ balances. If the local money quantum is contained at a certain level it would improve or retain its underlying value depending on the behaviour of relative variables such as forex inflows. Inversely, relaxation of money supply would increase inflation and worsen the exchange rate, two variables that are presently causing havoc to the economy, partially as a carryover accumulation effect from years of decimation both under President Mugabe and Mnangagwa, but emphasis has to be put on the fact that this surplus even by government’s own projections is only short term and is expected to evolve into a deficit of over $2 billion by year end. The projected deficit level will mean government has to seek additional borrowings from the private sector and this time the average interest rate demanded by lender will be above 10% implying a projected higher growth in money supply.

Even so, before the surplus is celebrated, there is a real need to interrogate downside effects of these present policy measures on a short, mid and long term basis, to ascertain the net implication, an evaluation which has not been effectively propagated in the current discourse of surplus evaluation. From a basic technical level, it will be important to highlight that the present fiscus surplus is as a result of accrual accounting which has the inherent drawbacks or not showing the real cash position regards national income. Cash accounting is when transactions are recorded at the point cash is exchanged while accrual accounting records financial flows at the time the economic flow is created, transformed or exchanged, regardless of whether cash is exchanged or not. So accrual accounting records transactions only at the point economic value exchanges hands other than when cash exchanges hands. The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized. The cash method is a more immediate recognition of revenue and expenses while the accrual method focuses on anticipated revenue and expenses. Zimbabwe’s treasury uses the accrual concept to value its transactions either revenue or expenditure.

Now, why is this a big deal?

Zimbabwe is running on tax arrears amounting close to $5 billion, half of which is in principal debt terms, implying that there is a huge probability of tax defaults especially in a year where the economy is expected to contract. Some of the tax arrears may be settled in 3 to 5 years’ time from now, while part of it may go bad for good altogether. In a period of high inflationary pressure, taxpayers typically choose to defer tax settlements and benefit from inflation as long as inflation is rising faster than the penalties.

The argument for cash accounting is therefore premised on the fact that it is prudent for government to only record receipts at the point of cash exchange than at the point of value transfer because the later (accrual accounting) inflates the short term income position and therefore may result in huge unrealised surplus or veiled net deficit positions. In essence governments using accrual accounting may continue to borrow despite declaring a cash surplus because some of the revenue will not have been realised. A surplus under accrual accounting may therefore likely inspire excess spending under the impression that money has already been made. This excess spending will have to funded by borrowings on the short term and the interest burden may reduce future surpluses if not inspire deficits. Most economies have already migrated to cash accounting and in the case of the EU, the move  was completed as far back as 1999. A breakdown of the $443 million surplus is thus important in determining how healthy it is and its net effect on government borrowing activities.

Moving away from the technical argument to more fundamental considerations

Inflation Factor

Inflation was one of the key drivers of income earned from the real sector in 2018, although indeed volumes went up on average. The inflation was mainly stimulated by cracks in the economy emanating from a monetary implosion particularly in the second half of 2018. Inflation went from a mere 2% earlier in 2018 to 46% by the end of the year. The emergence of high inflation means corporate incomes successively drove most tax lines upwards such as VAT and corporate tax, lines which dependant on income and spend. Since the final quarter of 2018 tax revenue has therefore been boosted by unsustainable inflationary pressures, which in turn has had adverse downside effect to the economy. In essence, as at first quarter 2019 industry had already begun to realise declining demand due to plummeting purchasing power which easily gives a projection of reduced production volumes for the remainder of the year. This produce, on an aggregated basis, is whats termed GDP. The IMF and World Bank together with analysts at Equity Axis, projects a combined GDP growth averaging -3.4% in 2019, a recession.

Residual firm aggregate demand from 2018, which the economy benefitted from in the first quarter of 2019 as a carryover effect from years of liberal fiscal policy measures and market controls, will gradually fizzle out against the loss in purchasing power, and this impact will be felt on ZIMRA revenue in the second half of the year, going forward. The rate at which demand softens will be determined by inflation and exchange rate dynamics in the absence of government intervention both on the monetary and fiscal side. However, judging by the quantum of government intervention through agriculture subsidies now revised at circa $1 billion (subject to exchange rate fluctuations) for maize alone in 2019 as announced yesterday at the Cabinet Briefing, it appears Treasury is loosening on austerity. There has also been further loss of income from a reduced fuel levy, which will contribute to revenue collections softening in the second half of the year, worsening the net fiscus position.

Moving forward, according to the published first quarter bulletin, Treasury highlighted that a positive variance of $240 million in expenditure which contributed to the celebrated surplus was driven by a deferment in expenditure on capital projects as well reduced maintenance costs. Capital projects accounted for only 10% of total expenditure at $174 million against a TSP target of 25% and a 2019 budget target of 25% on capital and debt repayment. What this means is that 90% of expenditure in the first quarter was pushed towards recurrent expenditure as government struggles to contain the ongoing crisis, against a target recurrent expenditure of 75%.

In a post cabinet briefing last week, the Minister of Information highlighted that a good measure of capital projects lagged behind target and some have been deferred due to the impact of price escalations in the economy. The revised 2019 budget or supplementary budget which will be announced in July will show a 30% allocation towards capital expenditure which is 20 percentage points worse off than that achieved in the first 3 months of the year. This taints the quality of surplus and its sustainability given that only non-recurrent expenditure has the propensity to spur economic growth in the positive direction on a sustainable level.

Further discounting the surplus, is the latest ZIMSTAT findings on the average monthly cost requirements for a family of 5, which the statistics agency said is now at $924 (April) up from $555 in the same period last year in RTGS terms. What this statistics highlight is that over 80% of Zimbabweans are now living beyond the poverty datum line levels. Much of the effect is coming from punitive taxation emanating from the 2% tax and its inflation igniting impact from 2018, together with other contractionary policy measures pursued. The challenge here is that these measures cannot be sustained on a mid to long term basis. In the very short term Zimbabwe is already beginning to feel the negative effects, since the economy had no ready strength to absorb the impact of austerity. Debt levels in private sector will especially rise but it is the likely recurrence of non-performing loans which are already retracing northwards, driven by austerity strain which is worrying. A near implosion now seems inevitable and this is typically characterised by civil unrest and untamed price spiralling as economic agents respond to save margins and to survive. Aggregate demand is already easing and companies are losing earnings, costs are rising and production is easing, incomes are under serious inflationary attack and general levels of government approval coming off.

It is just too early to celebrate the fiscus gains, it is also irresponsible to mislead the generality that the economy is on the mend. Celebrating same is the equivalent of  celebrating a 3% economic growth in Mugabe’s last term, a time when money supply was moving at a scale not commensurate with the economic growth levels, the result was economic overheating. The surplus therefore needs to be intricately interrogated to ascertain its quality and implications. It is important to always discount for the opportunity costs, for indeed there is no free lunch in economics. Questions should be asked such as What is being forgone and at what cost, what are the alternatives, what is the net cost.

The TSP using the tabulated macroeconomic framework, as presented in October 2018, is indeed now a pie in the sky and the same goes for 2019 budget targets which have largely already been missed. Of cause at the end of the end year we will be told the Deficit to GDP levels is within target of 5% and this will be premised on a fake GDP computation which simply multiplied the 2018 national produce by the prevailing interbank rate. Austerity is a path that need parameter setting before its undertaking and there were no such parameters to cushion the downside and the implication is there for all to see, the cost far outweighs the benefit. After all this has been said, it eludes most observers that the Minister of Finance is already projecting a deficit in the same range as last year by year end, which makes the debate about surplus fundamentals realignment a mere waste of time, the proof like pudding, is indeed in the eating.


Respect Gwenzi

Respect is the Lead Analyst and Managing Director at Equity Axis. He has 8 years experience in respective fields of finance and media. Particular areas of expertise include Asset Management, Stockbroking and Financial Media. Respect is on a mission to change the course of Financial Media in Africa through digitalization

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