JOHANNESBURG – This afternoon Finance Minister Tito Mboweni presents an extremely challenging Budget. The discomforting reality is that South Africa has a serious fiscal problem.
For nearly a decade since the global financial crisis, South Africa has followed countercyclical fiscal policy, maintaining big budget deficits in the expectation that eventually gross domestic product (GDP) growth would recover and generate a bounty of tax receipts to fund debt repayment.
However, after a decade’s worth of persistent growth disappointments, South Africa is now out of room to manoeuvre. Public indebtedness has more than doubled from 26 percent of GDP in 2008/09 to a projected 56 percent of GDP currently – with further increases pencilled into the National Treasury’s planning horizon.
Despite big tax hikes and to a lesser extent some expenditure restraint over the last couple of years, South Africa’s budget deficits are still too wide to stabilise the debt ratio.
At the time of the Medium Term Budget Policy Statement (MTBPS) in October, the National Treasury forecast a main budget deficit of 4.3 percent of GDP this year, and projected a broadly sideways trajectory for the next three years. A deficit of 4 percent of GDP may not sound like a large number but the arithmetic of debt dynamics – the way a country’s debt burden evolves in response to the Budget balance, inflation, the exchange rate and growth – is relentless.
When the real (ie inflation-adjusted) interest rate at which a country borrows exceeds real GDP growth, the country needs to run a primary Budget surplus to stabilise the debt ratio. However, we are currently nowhere close.
Given a Budget deficit of 4.3 percent of GDP and interest payments on the government debt amounting to 3.6 percent of GDP, South Africa is currently running a sizeable primary deficit of 0.7 percent of GDP.
Thus our debt burden looks set to continue growing until such time as growth accelerates or the government tightens fiscal policy by about 1 percent of GDP. The longer adverse debt dynamics are allowed to run, the more slippery they become.
Already interest payments on the government debt are the fastest growing item in the Budget, with projected growth of nearly 11 percent per annum over the next three years.
On the current trajectory, the government’s debt service costs will overtake its spending on social grants in 2021/22.
What can any government do in the face of such challenging debt dynamics? Unfortunately, while there are obvious answers from an economist’s perspective, they are rarely politically palatable. One approach is to bite the bullet and tighten the fiscal stance further, either by raising taxes or by cutting spending.
However, this is contractionary for aggregate demand, and can weigh on GDP growth in the short run. Strong consolidation measures seem unlikely at this juncture.
For one thing, the government’s promise at the Jobs Summit last year not to impose any mandatory retrenchments in the public sector would seem to hobble its ability to further curtail spending, although the MTBPS disclosure that the staff turnover rate in the public sector is a high 6 percent perhaps offers some scope to shrink headcount through natural attrition.
Furthermore, the negative public reaction to the 1 percentage point hike in VAT in the 2018 Budget shows little social tolerance for higher indirect taxes, while the paltry response of personal income tax receipts to the tax hikes of the last few years indicates that perhaps higher tax rates have undermined the narrow tax base.
Positively, however, we think that current efforts to rehabilitate South African Revenue Service, including the process to appoint a new head, ought to gradually boost the efficiency (and hence the quantum) of tax collections over time.
The government could also look to restructure its balance sheet, selling assets which are currently earning a negligible rate of return and using those receipts to avoid incurring further debts, on which it pays more than 9 percent interest.
While the governing ANC has long clung to the idea of its State Owned Companies (SOCs) as key for a developmental state, there are hints of a lively debate on this front, not least because of the urgent challenges at Eskom. However, the issue of privatisation is a point of fierce ideological contestation within the ANC and in South Africa more broadly.
The recent ANC lekgotla, for example, approved the unbundling of Eskom but nixed any associated privatisation. Organised labour remains bitterly opposed.
Still, the scale of South Africa’s fiscal challenges, both within the budget itself and at loss-making SOCs, argues for bold measures now. Such measures might entail some short-term pain, but any serious efforts to stabilise South Africa’s public finances would also almost certainly lift business confidence, and hence private investment spending, and thus ultimately growth.
And sustainable growth, in fact, is the most palatable solution, not only to South Africa’s fiscal challenges but also to its broader socio-economic ones.
Unfortunately for everyone, growth outcomes are a result of a complex interplay of many endowment, cyclical and policy factors. It is not possible to turn up growth by simply flicking one or two easy policy switches.
Many of the structural reforms needed to lift South Africa’s growth rate – such as selective labour market liberalisation and educational reforms – are hard and are outside direct control of the National Treasury.
While the government under President Cyril Ramaphosa seems to be moving in the right direction, there is a lot to do and consensus seems hard to secure. Still, government finances are a good place to start.
Mboweni clearly understands the issues. Two weeks after he was appointed, he had to present the MTPBS, which basically left fiscal policy on hold. Afterwards, however, he lost no time explaining to Parliament, to the media, to the markets, and to South Africa’s citizens that the status quo is unsustainable.
He said that South Africa “must choose a path that stabilises and reduces the national debt” and must curb the high growth in the public sector wage bill.
He even went as far as to tell Parliament that unless South Africa took action, it would ultimately have to go cap in hand to the International Monetary Fund. These are strong words and show that Mboweni appreciates the need for strong action. And yet, at this particularly political juncture, it is not at all clear how much he can deliver.
Some modest steps to ensure the Budget deficit targets are narrowed slightly are possible, but the really tough fiscal choices may be deferred until after the elections, in the hope political progress and other economic reforms will generate a bit of a growth pick-up that can shoulder some of the burden of fiscal consolidation.
Peter Worthington is a senior economist at Absa Corporate and Investment Bank. The views expressed here are his own.