SOUTH AFRICA'S 2006 BUDGET

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SUBJECT: SOUTH AFRICA'S 2006 BUDGET


1. Summary. Finance Minister Trevor Manuel outlined South
Africa's planned expenditures and revenues over the next
three years in the Budget 2006. Few finance ministers have
the luxury of dispensing an unplanned $6.9 billion in
revenue, and having close to a balanced budget. Strong
growth and improved tax collection improved South Africa's
fiscal balances enough to give lower and middle income
individuals and more small businesses tax relief, as well as
modest increases in social grants aimed at the poor. Key to
achieving government's goal of accelerated growth is
increased spending on infrastructure and education, along
with increased investment. Reaction to the Budget was
mostly positive, with the major complaint coming from big
business, which did not receive any tax cuts. End Summary.

After Climbing Mountains, Come Joys
--------------


2. Finance Minister Trevor Manuel opened his February 15
2006 Budget address to Parliament with the theme, "there are
no joys without mountains having been climbed," a phrase
borrowed from Nigerian poet Ben Okri. Manuel touted South
Africa's GDP growth to be 5% in 2005 (Note: 2005 growth
officially came in at 4.9%. End Note.) and in the years
ahead, noting in Zulu that "this is the year of plenty, when
all South Africans will reap the fruits of economic growth."
Manuel highlighted South Africa's accomplishments and plans
for the future, stating that since 1994, 3.5 million
households have been given electricity, water is accessible
to 90% of the population, and sanitation services are
improving. He also said that housing subsidies will provide
for 500,000 houses over the next three years and that 1,500
new jobs are now created each working day. In terms of
challenges facing South Africa, Manuel underlined investment
in infrastructure and skills development as the two most
important.

A River of Revenue
--------------


3. Strong economic growth and improved tax collection meant
the government collected R41.2 billion ($6.9 billion) more
revenue in the 2005/06 fiscal year (ending on March 31),
than it had estimated in the February 2005 budget. Manuel
proposed using the extra tax revenues to provide personal
tax relief, reduce budget deficits, and increase spending on
infrastructure and social grants. He announced R19.1
billion ($3.2 billion) in tax relief to primarily middle to
lower income brackets (those earning less than R250,000 or
$42,000). Additionally, he proposed plans to reduce
projected deficits to an average of 1.4% over the next three
years, compared to previous planned deficits of over 2%, as
well as to spend an additional R15 billion ($2.5 billion) on
increased infrastructure and social grants.


4. In fiscal year 2005/06, South Africa's budget is nearly
balanced, as its strong economy and improved tax collection
gave South Africa its lowest budget deficit in 25 years.
Manuel announced that the National Treasury's estimated
2005/06 budget deficit is now 0.5% of GDP compared to an
October 2005 estimate of 1% and a February 2005 estimate of
3.1%. If this estimate holds, it would be the lowest budget
deficit since 1981's deficit/GDP of 0.4%. Manuel also
forecasts smaller deficit/GDP ratios for each of the next
three years even as the SAG increases its expenditure
growth. He estimated South Africa's budget deficit at 1.5%
of GDP in fiscal 2006/07, easing slightly to 1.4% in 2007/08
and reaching 1.2% 2008/09. These revised estimates compare
to previous forecasts of 2.2% of GDP in fiscal 2006/07, 2.1%
in 2007/08 and 2% in 2008/09, made last February. Manuel
also lowered its forecast for public sector borrowing to
0.6% of GDP in fiscal 2005/06 and an average of 2.4 percent
over the next three years.

Personal Tax Relief
--------------


5. Manuel announced tax cuts for individuals, small
businesses and retirement savings. Personal taxes were cut
by R13.5 billion ($2.3 billion) with 73% of the reductions
focused on individuals earning R250,000 ($42,000) or less.
The top tax bracket at which the 40% marginal rate applies
will increase to R400,000 ($67,000) from R300,000 ($50,000),

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while the tax threshold at which employees begin paying tax
increases to R40,000 ($6,700) from R35,000 ($5,800),
beginning in April.


6. Manuel proposed reducing the tax on retirement savings
by half to 9% starting March 1 in order to boost South
Africa's low savings rate. In addition, taxes on property
were reduced with the lower limit of property value being
subject to taxes increased to R500,000 ($83,000) compared to
the previous threshold of R190,000 ($32,000). Since 1996,
there has been more than R80 billion ($13 billion) in
personal income tax reductions, mainly aimed at lower and
middle income groups.

Small Firms Benefit in Corporate Tax Proposals
-------------- -


7. Manuel increased the pool of firms eligible for small
business loans. Small businesses are now defined as having
annual revenues of R14 million ($2.3 million) or less
compared to last year's revenue cap of R6 million ($1
million). Manuel also announced that the income threshold
for the lower 10% corporate tax rate would increase to
R300,000 ($50,000) from R250,000 ($42,000) in 2005.
Industry analysts had expected Manuel to reduce the top
corporate tax rate, currently at 29%, or the secondary tax
on companies, at 12.5%, but neither happened. The regional
services council (RSC) taxes, payable to municipalities,
were abolished amounting to a tax reduction of R7 billion
($1.2 billion). Manuel made no announcement on whether
there would be a replacement tax. The minister also raised
thresholds for capital gains tax to account for inflation.

Only Sin Taxes and Road Fund Levies Increased
--------------


8. Manuel did increase taxes on alcohol, tobacco, and fuel.
The tax increases on alcohol and tobacco will increase
between 9% and 20% and between 5% and 10%, respectively. A
5 rand cent per liter increase in the Road Accident Fund
charge will increase the prices of gasoline and diesel. The
overall tax burden averages 26.5% of GDP, higher than the
previous government commitment of 25%.

Expenditure Plans
--------------


9. Spending on social services remains the key priority
over the next three years, accounting for 53% of total
spending in 2006/07 and increasing 12% per year. Manuel
announced increased social security grants of R80.6 billion
($13 billion). Disability and old age grants will rise to
R820 ($137) per month, an increase of R40. The foster care
grant will be R590 ($98) per month, an increase of R30.
Finally, the child support grant (reaching children up to
the age of 14) increased by R10 to reach R190 ($32) per
month. Manuel also announced an additional R34 billion
($5.7 billion) for planned infrastructure spending over the
2006-2009 Medium Term Expenditure Framework. Expansions in
the commuter rail network, water and road infrastructure
will increase infrastructure spending sharply as South
Africa prepares for the 2010 World Cup and implements the
Accelerated and Shared Growth Initiative.


10. All government expenditures during 2005/06 fiscal year
increased by 13.7%, higher than the 12.9% planned in the
February 2005 National Budget and the 12.8% increase posited
in October 2005 Mid Term Budget Policy Statement. In
2006/07, expenditure should increase 12.8% with an annual
average of 10.9% over the next three years. As a percentage
of GDP, expenditures will increase from 26.9% in 2005/06 to
27.6% for the next year and easing to 27.3% by 2008/09.

Exchange Controls Eased
--------------


11. Manuel announced another easing of foreign exchange
restrictions on individuals. Individuals may now transfer
up to R2 million ($330,000) offshore a year, up from the
previous limit of R750,000 ($125,000). To promote
investment in other African countries, companies will no
longer have to own a majority stake in a foreign firm to
invest elsewhere on the continent. The present foreign
direct investment threshold of 50% will be lowered to 25%

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for investments by South African corporations and
parastatals.


12. Manuel said the government's foreign exchange control
amnesty had raised R2.9 billion ($480,000) in fees and R1.4
billion ($200,000) in taxes from money previously parked
illegally offshore. He identified total assets of R68.6
billion ($11 billion) from 42,672 applications for amnesty
and announced the completion of the amnesty program
announced in February 2003. Manuel said that 42,184 amnesty
applications were approved, 924 were withdrawn and only 20
applications were declined, with approximately 70% of the
disclosed assets illegal. The revenue raised through
amnesty fees will be used in public-private partnership
investments in community infrastructure and business
development in low income areas.

Comment
--------------


13. Initial reaction to Budget 2006 was mostly positive.
Business sector's disappointment stemmed from receiving no
reduction in either the corporate or secondary taxes;
however, the removal of the RSC levies did yield R7 billion
in corporate tax relief, along with reduced administrative
burdens of filing RSC paperwork monthly. Community
activists and opposition parliamentarians (Democratic
Alliance) argued that budget proposals did little for the
unemployed and pensioners. Grants to the poor increased in
real terms by 2%, although many argue that that the bulk of
the revenue windfall accrued to those having jobs.
Defending the modest increase in social grants, Manuel
warned against `populist' spending and noted the importance
of striking a balance between social assistance and giving
people the incentive to work. In addition, he did not think
the revenue windfall was sustainable in the future.


14. In the face of the March 1 local elections, Budget 2006
emphasized infrastructure spending, improved delivery of
services, and targeted tax relief. Most of the tax relief
is targeted towards lower and middle income workers, which
is not likely to slow consumer demand in the future. By
introducing a sharp reduction of taxes on retirement
savings, Manuel is hoping to increase South Africa's already
low savings rate and shift some of the demand side growth
into increased investment. By emphasizing increased
investment, Budget 2006 will help South Africa achieve its
accelerated growth path. More than ever, South Africa faces
a conflict between more redistributive policies shifting out
demand at the expense of higher prices or growth initiatives
aimed at expanding supply.

TEITELBAUM