Mapping a way out of SA's debt quandary
CAPE TOWN – Last week Finance Minister Tito Mboweni delivered his second Medium-term Budget Policy Statement (MTBPS) amid poor and worsening economic conditions.
Then on Friday 1 November 2019, ratings agency Moody’s affirmed South Africa’s sovereign debt rating at investment grade although changing the outlook from “stable” to “negative” – meaning that, unless changes are made to those factors cited as threatening our fiscal sustainability, government debt is likely to be downgraded – to sub-investment grade – at the next review.
The Moody’s review is, perhaps, more positive than negative. A downgrade to “junk” status was expected by many pundits and movements in the external value of the currency between the tabling of the MTBPS and Moody’s announcement suggests that traders may have been expecting a downgrade.
That this didn’t happen reflects some recognition of the efforts made thus far to contain the deterioration of South Africa’s fiscal position. The change in outlook, however, serves to warn officials that the reforms announced have not generated confidence – among Moody’s analysts, at least – that South Africa can avoid further deterioration of its public finances and, perhaps, ultimately default on its debt.
Normally, there are three ways for a country to contain an exploding debt burden without defaulting: reduce expenditure; raise taxes, or; grow your way out of the problem.
The third way aided massively during the last consolidation episode (spanning the 1999/2000 – 2006/7 period). Since 2010, however, South Africa’s growth has been weak and shows no signs of a rapid improvement.
We are thus unlikely to grow our way out of the debt problem in the near term. Yet, near-term solutions are required, leaving the two remaining options: cut expenditure and/or raise taxes.
Raising taxes is not a viable option to reduce growth in debt levels substantially. There are three main tax revenue categories: personal income tax (PIT), corporate income tax (CIT), and value added tax (VAT). Treasury has raised both PIT and VAT over the last few budget cycles without it reducing the government’s deficit and raising these taxes any further is likely to be politically infeasible – political infeasibility of implemented announced reforms is one of the factors cited by Moody’s in its recent review.
It is imaginable that a new “social contract” emerges and is promoted by government – one that inspires workers in the middle of the income distribution to pay more in taxes in exchange for a more stable, better growing future economy under the stewardship of a competent and prudent government – but, given the government’s recent record, this notion will likely remain in the realm of imagination.
Raising corporate taxes too is not feasible as it is already relatively high and may discourage what the economy needs most, investment in job-creating activities.
Finally, tax revenue has been routinely underperforming Treasury’s projections. This is in part due to GDP growth projections that are higher than realised, but possibly also due to administrative inefficiencies and tax avoidance and evasion. Increasing revenues significantly, though, can only be attained by promoting economic growth.
The government thus needs to cut expenditure. The challenge it faces is to reduce the debt burden while maintaining the high levels of social expenditure – education, health, social grants, community development – and without compromising economic infrastructure expenditure – investment in roads, transport, energy, broadband, water/sanitation.
Balancing these priorities is difficult in our current context. South Africa still needs to make significant progress in address legacy ‘backlogs’ in social infrastructure. Reducing the level or coverage of social grants, for instance, is presently unpalatable. Cutting on education or health expenditure is simply unthinkable.
Arguably, the previous round of fiscal consolidation came about, to some degree, at the expense of economic infrastructure which has resulted in reduced efficiency of energy generation and transport with a direct bearing on the capacity of the economy to grow and create jobs. In other words, by neglecting these important investment areas, we have reduced the economy’s potential to grow.
This result feeds back into the public financing problem since lower growth implies lower revenue generating capacity. Debt servicing costs – the interest government pays to holders of its debt each year – is the fastest growing expenditure item in government’s budget meaning that traditional expenditure items will be competing for fewer funds the longer it takes for government to reduce the deficit.
Government must therefore contain the rise in costs of implementing its various programmes. It must reduce the growth in – or, perhaps, even reduce the level of – compensation of employees.
The MTBPS tabled last week speaks to the core issues highlighted above: promoting growth through infrastructure investment and various other policy proposals, as well as curtailing growth in government expenditure. It also addresses one of the core concerns cited by Moody’s and other ratings agencies in their respective ratings reviews, which is the threat posed to public finances by dysfunctional state-owned enterprises.
It is notable that South Africa is not yet at the point where cuts to expenditure are being proposed. The term “austerity” does not appear in the MTBPS and proposed reforms do not include a level-reduction in aggregate expenditure. That is, the public budget will continue to grow and reforms are designed to stymie the growth in expenditure to avoid a spiralling debt burden.
Economically, this is a sensible approach as it avoids the trap of reducing productive expenditure that has the outcome of further reducing growth potential. As mentioned above, during the earlier debt consolidation period – which saw the debt burden halved over a seven-year period and resulted in a couple of budget surpluses – there was arguably a neglect of important infrastructure investment that had knock-on effects on the economy’s growth capacity.
The MTBPS, as well as earlier policy documents released by the Treasury, scrupulously precludes this outcome by trying to stabilise rather than reduce expenditure levels.
The MTBPS envisions achieving a primary balance (government expenditure excluding debt service costs that are equal to revenue) by fiscal-year 2022/23. It notes the following measures to achieve this:
- Reduce growth in expenditure by curtailing growth in the compensation of employees, and reducing other wasteful expenditure.
- Raise additional tax revenue
- Reform state-owned enterprises by selling off ‘non-core assets’ and introducing private-sector participation
- Reform state-owned enterprises
Implementing a credible turnaround plan for the state-owned enterprises (Eskom in particular) would be key to stave off a ratings downgrade in the next rating review. The MTBPS emphasises the importance of improving operational efficiencies and governance improvements within Eskom as conditions for further support from government. One proposed reform to achieve these outcomes is to break-up the utility into three separate entities.
It is thus hoped that this will reduce the scope for inefficiency and mismanagement while promoting accountability. The timeline of these reforms extend into 2023. Ratings agencies have to judge whether these reforms can be implemented within proposed timelines and, conditional on implementation, whether they will have the desired effect. There is thus a lot of uncertainty around these proposed reforms.
Raise additional tax revenue
Additional revenue generation measures are not detailed in the MTBPS and are instead deferred to the main budget review of 2020. It is, however, noted in the MTBPS that the space for significant increases in revenue is highly constrained.
There does appear to be some expectation that administrative efficiencies in SARS could also bring in some additional revenue. Although this is likely to have a limited impact on the fiscal position, it would nonetheless be an important step toward restoring state capacity where it has previously eroded.
Reduce growth in expenditure
The major budget item targeted with this reform is the compensation of employees or public sector wages. Proposed reforms target aspects other than general wage increases like pay progression and occupation-specific wage dispensations.
However, it is noted that changes to these compensation mechanisms will be difficult without the buy-in of labour unions. The MTBPS shows that, in aggregate, the real increases in compensation are slightly above inflation-adjustment increase. This implies that wages increased by more than double the level that would have occurred had wage increases have been linked to inflation rates. Reversing this trend is unlikely to be easy.
Other revised expenditure figures include provincial equitable share allocations and conditional grants. This will have knock-on effects on provincial programmes. Provinces may, in future, seek alternative revenue sources to fund programmes. Alternatively, they may have to reprioritise expenditures and potentially cease certain programmes going forward.
Charles Adams joined the Economics Department at UWC as a lecturer in 2018. He has several years experience as a researcher in the public sector having worked in a government department and legislature at provincial level and has published research on poverty and inequality.