Linda Ensor

Political Correspondent

CAPE TOWN — The expansionary budget for 2005-06 and the unprecedented boom in consumption spending could restrain the Reserve Bank from reducing interest rates in the short term, economists have warned.

They have also questioned the appropriateness of government’s expansionary fiscal policy in the current economic climate.

The budget announced by Finance Minister Trevor Manuel last week provided for a real 7,5% growth in government noninterest expenditure and extended R11bn in tax cuts to companies, individuals and small businesses.

The budget deficit was forecast to grow from 2,3% in 2003-04 to 3,1% in 2004-05.

Citadel head of asset management Dave Mohr said during a Deloitte budget briefing that the budget was pro-cyclical as it added government demand on to high consumer demand.

"That always runs the risk of an overheated economy over time," he said.

He said the Bank’s monetary policy committee had expressed concern in its last two statements about the very strong demand in the economy. This had made it postpone interest rate cuts despite very good inflation numbers. The Bank could postpone an interest rate cut once again in April for the same reason.

Mohr said that over the last three years there had been a "worrying" rise in government spending as a percentage of gross domestic product from 24,3% to a projected 27,3% this year. "Government seems to be increasing its share. That is something which needs to be watched."

Sanlam chief economist Jac Laubscher questioned the appropriateness of government’s fiscal stance at the current stage of the business cycle. He believed fiscal policy should have been less expansionary and dampened demand allowing for a further reduction in interest rates and possibly a weaker rand.

"The current mix of an expansionary monetary policy and a relatively strong exchange rate will be pulled further out of balance by an expansionary fiscal policy," Laubscher said.

"The use of fiscal policy as an instrument for macroeconomic stabilisation has been overtaken. As a result, monetary policy is the only policy instrument left in the quest for macroeconomic stability, and the burden it has to carry becomes unbearable."

However, Investec investment strategist Brian Kantor disagreed, saying the level of government spending was "entirely appropriate" for a developing economy such as SA’s as long as most of it was spent on infrastructure rather than consumption.

"The policy settings are appropriate. The plan is working. Growth is highly sustainable. The outlook is promising indeed."

Significant foreign capital inflows attracted by strong domestic economic growth could be expected, which would support the rand and ensure low inflation, which was more likely to be nearer 3% than government’s forecast of closer to 5%.

National treasury chief director Martin Grote said government believed the rand would remain "reasonably strong which has a huge benefit as it brings inflation under control".