What does it mean when ‘markets react positively’ to Wednesday’s budget speech? Why would they react positively, when it was laden with bad news?
On Wednesday, finance minister, Tito Mboweni, appeared before the nation without the potted aloe ferox he usually trots out for budget speeches as a metaphor for an economy valiantly struggling to grow and thrive in harsh conditions.
So why would Business Maverick send me an email entitled ‘Markets react positively to the budget’?
If you read the story to which it points, you soon discover that the reason is ‘it was not as bad as many expected’.
Mboweni chose not to pull the trigger on tax increases mooted in last October’s medium-term budget policy statement (MTBPS). He was able to do so because the tax shortfall of R213 billion on the projections of the 2020 budget was lower than the R300 billion shortfall anticipated in the MTBPS, largely thanks to an unanticipated surge in global commodity prices. This also enabled Mboweni to slightly reduce the anticipated need for issuing domestic debt in the coming year.
Mboweni’s promises were also pretty sweet. He remains resolute on a public sector wage freeze. He promises a primary budget surplus by 2024/5, which is a year earlier than the projection in the MTBPS. He promises government debt stabilisation at 88.9% of GDP by 2025/6, which is a significantly lower level than the 95.3% peak projected in the MTBPS.
So, it’s true that this budget was ‘not as bad as many expected’, but that doesn’t mean it was a good budget.
Promises, promises
Very little was said about actual structural reforms, and that is no surprise. According to the Centre for Risk Analysis (CRA), an advisory group, four out of five cabinet members are opposed to reform. More than half the members of the National Executive Council of the African National Congress (ANC) have been implicated in corruption at one point or another. Expecting the ANC government to reform is to expect it to change its entire character.
Yet without far-reaching reforms, Mboweni’s promises aren’t worth the paper they’re written on.
I will eat my hat if government debt really does peak at 88.9% in 2025/6 and begins to decline after that. Same with the primary budget surplus in 2024/5.
According to CRA data, government spending tracked around the 25% of GDP mark during the Mbeki era. It slowly rose to about 30% during the Zuma presidency, before sky-rocketing under Ramaphosa. After a corona-peak of over 40%, it is expected to remain above 35% of GDP for the foreseeable future.
Meanwhile, taxation revenue as a share of GDP was below or around 25% until Ramaphosa became president, when it suddenly spiked to near 30%. That is also not expected to decline. Despite the higher tax take, the gap between revenue and expenditure remains large, making the prospect of a budget surplus in the near term seem pretty far-fetched.
Curiously, the URL for the Business Maverick story has the headline saying ‘mixed reaction from economists’, but that was later changed to ‘reaction from economists largely positive’.
Perhaps this reaction didn’t count: ‘“This budget has a lot of PR. We will not turn at 89% debt to GDP,” said Mike Schussler of economists.co.za, noting the yawning budget deficits over the next couple of years.’
Debt consolidation
The ‘continued restraint in expenditure growth’ that Mboweni promised in his budget speech is hardly sufficient. We don’t need restraint in expenditure growth. Expenditure actually needs to be cut.
Mboweni’s ‘restraint’ entirely predicated on the hope that a wage freeze will be agreed with public sector unions. That would leave the government free to increase expenditure on other things.
A failure to reach agreement ‘will be unaffordable and compromise debt stabilisation’, Mboweni warns in the budget review.
That alone could sink Mboweni’s bold promises.
Worse, the idea of limiting public wage increases fails to acknowledge the true problem: that South Africa’s government employees earn 14.8% of GDP, compared to a 10.2% average for countries in the Organisation for Economic Co-operation and Development.
Of those rich-world countries, only Denmark and Norway pay their government workers more as a share of GDP, but then, unlike South Africans, Danes and Norwegians get a whole boatload of services in return, such as top-notch education, effective police, and world-class healthcare.
What South Africa really needs is to slash its public sector wage bill by a third. What are the chances Mboweni will get that past the unions?
An identified risk in the budget review is that the financial positions of public entities and local government remain weak as a consequence of poor financial management.
Yet the budget speech contained no mention of these entities, except to announce a R7 billion bailout for the insolvent Land Bank.
SOEs
The state of the state-owned enterprises remains dismal. ‘In 2020/21, financial performance appears to have deteriorated, with many entities operating below capacity, and facing subdued demand for goods and services. The implementation of turnaround plans has also been delayed,’ says the budget review. ‘Average profitability, measured by return on equity, has remained relatively unchanged at -7.9%. The negative return on equity is largely the result of weak revenue growth, high costs – driven by large compensation bills – and elevated debt-service costs.’
Eskom remains on taxpayer-funded life support and keeps issuing new debt to pay off old debt and cover operational costs. Meanwhile, it is unable to meet the country’s already very depressed electricity demand, and fleet performance continues to deteriorate.
SAA seems headed for a further bailout, despite all the promises to the contrary. SANRAL has incurred annual average losses of R2.5 billion for the last seven years and is technically bankrupt. The SABC continues to run at a massive loss. Denel is basically dead.
A further risk involves ‘the resolution of longstanding policy disputes – including the user pay principle’. Mboweni is pinning his hopes on making e-tolling work, first in Gauteng, and then across the country. That seems optimistic.
The risk to debt stabilisation from state-owned enterprises and bankrupt local municipalities seems to be enormous, and very little is being done about it.
Meanwhile, instead of realising that the government is pretty bad at running companies, Mboweni has promised to buy equity stakes in failing tourism businesses, ‘to support the tourism sector recovery’. Who wouldn’t want government as a business partner?
Infrastructure spending
Acting as if he’s not overseeing a nose-diving economy, the finance minister committed the government to a R791.2 billion infrastructure investment drive. This must be music to the ears of the construction industry, engineering firms, consultancies, project managers, and assorted friends-and-family middlemen, but it should make taxpayers and most other investors shiver in their boots.
The theory, according to Mboweni, is that government spending on infrastructure boosts growth. This is, by the government’s own admission in the MTBPS (see box on p.24), a tenuous proposition.
It cites research that empirically estimates fiscal multipliers to GDP in South Africa. This measures the amount of GDP created by a given amount of government spending. A fiscal multiplier above one means government spending results in a net boost to GDP growth.
The paper finds that ‘government spending multipliers are generally positive, albeit smaller than one’.
That means for every rand government spends, GDP will increase by less than a rand.
Worse, ‘[w]hile present-value spending multipliers remain positive over short horizons, the long-term spending multiplier turns negative in models that account for the effects of monetary policy’.
With negative multipliers, every rand that government spends results in a reduction of GDP.
So while infrastructure spending might have a higher fiscal multiplier than other forms of government spending, and some infrastructure spending is an unavoidable cost, it is far from clear that boosting infrastructure spending will result in a net gain to GDP.
Similarly, fiscal multipliers to investment and consumption range from just below to just above zero, and are nowhere near one. Increased government spending also cannot boost either of those.
Growth and ‘recovery’
Mboweni said that following a 7.2% contraction in 2020, GDP growth would rebound to 3.3% in 2021, and average 1.9% in the next two years. To assess whether this is good news requires two realisations.
The first is simple arithmetic. A 7.2% contraction, followed by three years of growth at 3.3%, 1.9% and 1.9% respectively, would fail to return the nominal GDP level to what it was before the contraction by the end of 2023. If that growth rate were to continue, GDP would only recover to pre-2020 levels by 2024.
This is lost growth that we’ll never get back. These are four or five ‘lost years’, to use the terminology commonly applied to the Zuma presidency, during which the total growth is zero.
Second, the CRA estimates that GDP projections in the budget are routinely overestimated, not because the government cannot forecast, but because it is trying to talk the country up.
In 2019, growth was forecast to be 2.2%. It turned out to be a meagre 0.2%. In 2018, the forecast was 2.0%, and reality was 0.8%. The remarkably low forecast in 2017 of 1.3% was the only one in the last decade that was exceeded, at 1.4%. In 2016, the forecast was 3.5%, the actual was 0.4%.
Going back to 2010, projected growth figures on average overestimated actual growth by a staggering 235%.
We can therefore assume that Mboweni’s growth projections are significantly exaggerated. If growth comes in at half the rate he anticipates, GDP would still be 3.9% short of its pre-2020 level by the end of 2023. It would only fully recover by 2028, giving us eight ‘lost years’ of effectively zero growth.
If actual growth is as low as would be consistent with the forecasts discrepancies since 2010, we won’t see pre-2020 GDP levels until 2033, resulting in 13 ‘lost years’.
Expectations
All this would lead a disinterested observer to expect very little from the budget Mboweni presented. His forecasts are hopelessly Pollyanesque.
Ratings agency Fitch issued a post-budget advisory that reads: ‘We continue to believe that [expenditure] cuts of this scale will be difficult to achieve and maintain more conservative assumptions than the government about the pace of fiscal consolidation.’
It mentions several other challenges in meeting fiscal consolidation and debt stabilisation goals and does not share Mboweni’s optimism.
The rand, after trading briefly stronger in the wake of the budget speech, has been slipping against the US dollar. The 10-year bond yield also briefly rallied, but that rally could also not be sustained.
Any ‘positive reaction’ from the markets was positive only briefly, and only by comparison with short-term expectations. Over the medium and long term, expectations for South Africa’s economy remain exceedingly poor.
All of which leaves only one explanation for what happened to Mboweni’s long-suffering aloe ferox. It is dead.
The views of the writer are not necessarily the views of the Daily Friend or the IRR
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Image: John Atherton, CC BY-SA 2.0 https://creativecommons.org/licenses/by-sa/2.0, via Wikimedia Commons