Government finances are in deep distress. Even before the Covid-19 package of support measures, South Africa had a crisis-level government budget deficit and debt was rising to unsustainable levels.
The Covid-19 crisis has brought South Africa’s fiscal day of reckoning in the form of a debt trap closer. A debt trap would force the choice of a default or monetisation of the deficit by the central bank. Pending default could force the rescheduling of debt, which would lead to an IMF program and reforms; monetisation driven by populist politics would lead to hyperinflation and bringing the economy to its knees.
The crunch comes when government is unable either to raise sufficient tax revenue or to borrow to service its debt, and cannot cut its spending.
Worsening economic situation
The special adjustment budget, which Finance Minister Tito Mboweni will deliver to Parliament this afternoon is unlikely to fundamentally change the country’s fiscal trajectory.
The budget will detail R130bn in cuts from the February budget to make way for the reprioritised spending that made up part of the R500bn Covid-19 emergency package. There should also be details on how the extra R270bn in spending will be financed.
Economic conditions have substantially worsened with the Covid-19 crisis and a number of forecasters are expecting an economic contraction of about 10 percent this year. That will mean substantially lower tax revenue, a higher deficit, and the need for more debt to finance the gap.
Papers released last week at a National Economic Development and Labour Council meeting show the Treasury expects a budget deficit of 14 percent of GDP this fiscal year. That is more than double the 6.8 percent that was projected in the budget presented in February. With these projections, debt is soaring.
By 2025, the Treasury projection is now for debt to be at 100 percent of GDP and by 2029 it will approach 113 percent.
With South Africans overtaxed by international standards there is very limited scope for new taxes. A “solidarity” wealth tax is unlikely to raise much more revenue. And raising VAT or bringing in new taxpayers at the lower end might spark mass public protest rather than a vast inflow of new revenue.
Raising taxes in the absence of public sector wage cuts would have to be seen as arrogant indifference to the economic pain the country is facing. The plan in February was to cut R160bn over three years in the projected increase in civil servants pay. Unions, whose strength now lies in the public sector, were outraged. But with the current crisis there is now no justification for their protest. Similarly, there can be no justification for the plans to try and resurrect SAA or further bailouts for Eskom.
Ministers have taken pay cuts of one-third for three months, but further public sector wage cuts by finally taking on the labour unions has become key to averting a debt trap. The big political test for any fiscal consolidation is the extent to which government can take on the labour unions.
For how long government can continue to kick the fiscal can down the road while it satisfies its constituencies will depend on what sort of loans it can patch together.
A $1bn loan from the New Development Bank, a bank set up by the BRICS countries, Brazil, Russia, India, China, and South Africa, has been confirmed. Treasury has also applied for a $4.2bn loan from the International Monetary Fund, which carries no policy conditions. It has also asked the World Bank for money, and as investor appetite wanes for South African paper, there will be more appeals for loans. These loans will all add to the debt burden, and South Africa’s recourse to such loans is a sign that there is an in increasingly tight market constraint on its borrowing.
But big money is not made available on a non-conditional basis, which means that at some stage government’s options will drastically narrow.
President Cyril Ramaphosa’s vision for a ‘state-led’ recovery as in post-war situations will be impossible to implement. After World War II the recovery in Western Europe was paid for by the US-financed Marshall Plan. There is no source of massive aid available to South Africa.
Government has been trying to draw South Africa’s big corporates into infrastructure partnership. Allowing private contractors to build, manage, and operate projects without government could help avoid the multitude of problems with public sector management. But having government set user charges and ensuring these are paid will be a continuing problem.
What the big tax and big spenders call a ‘whole of public sector balance sheet approach’ to funding would further undermine the country’s fiscal position. Use of the Development Bank to bail out failing SAA was stretching this institution’s mandate beyond credibility. Drawing financing from such institutions or indeed from private pension funds, through prescribed assets, to ultimately finance government deficits would exact a severe toll on the country.
For some time increased public sector spending has lowered growth rather than been the economic multiplier wished for by the proponents of big spending. In South Africa, as government has taken on a larger role, growth has declined. Public sector spending is simply not as productive as that of the private sector.
Looming debt trap
Without policy reforms to boost growth, government is heading into a debt trap. There are no sustainable financing options left if it cannot boost its creditworthiness, which has been in virtual free fall.
In this paper, written by Professors Philippe Burger and Estian Calitz a fortnight before the lockdown, they said a debt trap could be looming for South Africa. Government now has an even faster-rising debt-to-GDP ratio in an environment in which it is unable to raise more revenue through increasing tax rates and unwilling to reduce spending to ensure stable debt levels.
As its debt burden keeps increasing it is likely to find it increasingly difficult to find buyers for its bonds. “Ultimately, once it cannot find such buyers, the debt trap shuts,” they write.
When it shuts there are two options that Burger and Calitz put forward: government defaults on the debt, destroying its national and international credit reputation, or government “prints money” by forcing the central bank to take up its new debt issues. That is monetising its deficit or printing money. Option two is the Zimbabwe and Venezuela course, which has meant hyperinflation.
As the Bank is independent and has the mandate of maintaining the value of the currency, much would have to change in South Africa for this to happen. There is also a Southern African Development Community rule against central banks taking up more than ten percent of government debt. But would this independence hold in the face of a desperate government and populist politics?
Default or monetisation of the deficit, or indeed a combination, would mean longer and harsher pain than any big temporary cuts in spending. The longer the ANC postpones making crucial budget decisions, the harsher the economic pain will be.
The views of the writer are not necessarily the views of the Daily Friend or the IRR