Over the last few years, the size of the US budget deficit caused considerable angst among investors and “prophets of doom” obsessed over the national debt clock ticking over. In Congress, fierce budget battles were fought, almost pushing the US into defaulting on its debt.
However, South Africa’s deficit is larger as a percentage of gross domestic product (GDP) in comparison with the US’s deficit, and the market’s leniency towards emerging economies with deficits has come to an end.
Graph 1: South Africa’s deficit is larger as a percentage of GDP than the US. In mid-2009, both the US and South Africa’s tax revenue fell as the economy went into recession, while “automatic stabilisers” and fiscal stimulus measures led to increased spending.
The US Federal deficit widened to over 8 percent of GDP, worrying investors as the Federal debt-to-GDP ratio headed to triple digits. Meanwhile, emerging markets such as South Africa were praised for having smaller deficits and lower debt ratios.
Graph 2: Spending restraint needed to close the deficit in the US, Federal spending trended broadly sideways for five years, while tax revenues improved in line with a recovering economy, resulting in the Federal budget deficit being on track to fall below 3 percent of GDP this year.
Unlike the US, spending in South Africa has soared 40 percent over the last five years, with the public sector wage bill doubling as a result of about 250 000 extra civil servants being employed and salary increases well above inflation. Welfare grant spending also rose rapidly over this period.
While tax revenue growth in the country returned after 2009, there has not been any “catch-up” revenue growth, and it is unlikely there will be going forward. This is mainly because economic growth is disappointing and increases in tax rates could further harm growth.
The resulting large deficits have seen South Africa’s debt ratio climb rapidly, while the cost of servicing past deficits has become the fastest-growing item in the Budget.
The global environment has also changed, and markets and credit ratings agencies are no longer willing to give emerging markets with high deficits and rising debt ratios a free pass.
In contrast to the US, local bond yields have risen sharply over the past year, increasing borrowing costs.
In summary, the South African government will have to reduce spending growth significantly to cut the deficit to internationally acceptable levels.
* Dave Mohr is the chief investment strategist for Old Mutual Wealth.