While Finance Minister Pravin Gordhan will be relieved that fraud charges against him were dropped, political infighting is not the greatest challenge on his plate, writes Pierre Heistein.
Gordhan is in charge of how much government spends at a time when real gross domestic product (GDP) growth has been revised downward to 0.5 percent for this year. The economy needs stimulus but Gordhan has to keep in mind that the government budget is already in a deficit. Closing the deficit requires government to spend less and tax more.
This is where steering the economy as Minister of Finance becomes like flying a plane through the Knysna Heads; it is a balance of spending enough to keep the economy afloat but not growing the deficit to a point where investment flees. Add active opposition from the president and it is like flying that plane with a broken wing.
Gordhan needs to avoid a low-growth trap - a cycle where low economic growth causes even slower growth. In the case of a slowing economy, tax revenues decrease leading to a widening of the budget deficit. The government can either leave things as they are and fund the deficit through debt, or consolidate the budget by decreasing spending and increasing tax revenue.
Consolidating the budget - as proposed by the medium-term budget announced last week - may instil confidence but it undermines government spending programmes. Raising taxes leads to less disposable household income and depresses the growth of consumption. If this leads to lower growth, then tax revenues will once again decrease, putting renewed pressure on the budget deficit - a vicious cycle.
Growing expenditure
But doing nothing to curb spending will be even worse. The government’s debt exceeds R2 trillion - 45.8 percent of GDP. Debt servicing costs are the fastest growing expenditure category and are expected to reach R147.7 billion in the 2016/17 financial year, rising to R197.2bn in 2019/20. The government spends nearly as much on servicing debt as it does on public health.
Allowing debt to grow makes the government a risky debtor and creditors will demand higher lending rates - increasing the cost of borrowing for government. The rate at which government borrows money partly sets the rate for the rest of the market; if government’s cost of borrowing goes up, interest rates across the rest of the economy will rise, stifling investment.
A larger debt burden will lead to a credit rating downgrade, causing capital outflows, even higher interest rates and a depreciation of the currency. This would create a difficult environment for investment and even were government to allow taxes to remain low and spending to rise, the economy would continue to stagnate.
The solution is to maintain a careful balance. Gordhan aims to consolidate the budget without choking the economy and lay a stable framework for private investment to provide the stimulus to growth. If government can maintain this balance, Treasury forecasts that growth can be increased to 2.2 percent by 2019.
Production in agriculture, forestry and fisheries fell 8.3 percent in the first half of this year compared with the same period last year due to two consecutive seasons of drought. More rain and the depreciated real exchange rate are expected to boost agriculture exports next year and return positive growth to the sector.
The recapitalisation of Eskom last year improved infrastructure maintenance and led to greater electricity supply. Electricity availability improved from 70 percent in October last year to 81 percent in June. Increased electricity generation from Medupi and Kusile will come online towards the end of the medium-term budget period.
The government has also launched a number of specific initiatives that, if implemented properly, will aid the private sector in boosting production.
The Independent Power Producer programme has been expanded to include gas and coal. The Cities Support Programme is working with South Africa’s major cities to speed up processes regarding electricity supply, registering property and getting construction permits. The broadband spectrum allocation will be improved and InvestSA has increased programmes to help investors entering the local market.
* Pierre Heistein is the instructor of UCT’s Applied Economics for Smart Decision Making course. Follow him on Twitter @PierreHeistein.
* The views expressed here do not necessarily reflect those of Independent Media.
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