This afternoon, the Finance Minister, Enoch Godongwana, will present his Medium-Term Budget Policy Statement (MTBPS) to Parliament, outlining spending, taxation, and borrowing plans for the next three years. His primary job will be to try and rebuild confidence in the government’s deteriorating finances. A massive under-collection of taxes, large overspending, and a build-up of debt are pushing the country into crisis.
Against the political pressures of an election next year, minimal economic growth and growing global uncertainty, the Minister has a difficult job. With an election looming, he can’t make cuts that will make a large difference. But he will also probably not be able to do much to bring about fiscal stability after the election or the following year. The ANC is in decline, and it is being forced to increasingly defer to vested interests among its civil servants: the unions, the tenderpreneurs and grant recipients.
The bond market knows this, and that is why the interest on South African government debt is likely to rise further to compensate for the increasing risk that lenders are taking. In short, our position is increasingly precarious, and there seems to be no easy way out.
Tax revenue has grown at well below expectations this fiscal year. From April to August this year, gross tax revenue rose by an annualised 2.5 percent on the previous year, compared to the 5.6 percent rise that was expected for the entire fiscal year in the budget, says the Bureau for Economic Research (BER). Lower commodity prices and the record severity of Eskom’s power cuts in lowering growth have severely pushed down tax revenue.
Tax shortfall
Yet despite the tax shortfall, the BER says spending has risen by more than nine percent on last year, well in excess of the 1.5 percent that was expected in the February budget. This and the revenue shortfall could result in a budget deficit of seven percent, says the BER. And the debt to GDP ratio might soon be over 72 percent, or even as high as 80 percent, say Investec economists. That debt ratio would be safe for a fast-growing economy, but it is not for one like ours with structural growth problems.
It looks increasingly unlikely that the Treasury will be able to manage us out of this mess, as the government lacks the political guts to deal with the problem.
In the absence of managed cuts, the way out might be a crisis brought on by ever rising borrowing requirements. It will be messy, but that is the nature of crises. In the event of a loss of appetite for South African government bonds cuts, the political will of the ANC will be forced. As our local banks are large holders of government debt, the consequences of a government default would almost certainly be a squeeze on banks if not a full-blown financial crisis. The Reserve Bank might then intervene to save the banks and the financial system, laying the basis for massive inflation. Clearly it is best to manage a crisis in good economic times and failing that, to ensure that there are well-managed cuts.
In theory we could go on for years testing the limits of our borrowing capacity without making serious cuts. But there is always that sudden breaking point that could loom in the form of an unforeseen event that brings about a serious and unexpected break in confidence.
Government bonds
Our government bonds are already under pressure. In March 2020, the Reserve Bank had to intervene in the market, as foreign bond holders suddenly headed for the exit during the period of global risk aversion in the early stages of the Covid pandemic. This year the ten-year government bond yield has been on an upward trend, although volatile. The yield of a bond rises inversely to price, therefore weaker demand is reflected in lower bond prices and higher yields. And, significantly, the yield curve which reflects yields at different maturities has been steepening, showing nervousness about what may lie ahead for the country’s fiscal position.
Another impetus towards a crisis could occur with the adverse international environment for debt. Global central banks are almost certainly likely to retain interest rates for longer, due to the concern about rising oil prices sparked by worries about the Israel-Hamas war. There are also worries about the high debt levels in both advanced industrial economies and emerging markets.
The only way the Minister can restore confidence is to demonstrate that he can make politically difficult cuts. These include ending bailouts to state-owned enterprises and not extending the Social Relief of Distress Grant beyond March next year. But the big structural reforms like privatisation and easing the regulatory framework to boost growth also need to be taken. These, at least, would stand a chance of boosting growth. But pushing through structural reforms is not part of the Minister of Finance’s areas of responsibility.
With the ANC facing its toughest-ever challenge at the polls, the Minister can’t massively cut bailouts to Transnet, which would risk worsening bottlenecks and delays on railways and ports. He can’t cut bailouts to Eskom as it would mean worsening power cuts. He can’t cut civil service pay as there is a wage deal in place. He can’t cut the number of civil servants or workers in state-owned enterprises, as that would risk turning the unions against the ruling party. And the ANC has proved that big structural reforms are not something that it can politically undertake.
The sort of cuts the Minister can make are likely to be peripheral. It is very difficult if not politically impossible to substantially cut more than 70 percent of government spending. Debt service has to be paid, and items such as grants, public healthcare, education, and much of the allocation to police and defence also cannot be seriously cut. So it is items like the General Public Services category, which includes Foreign Affairs, that will need to be cut.
We still have to see how far the government can go with its planned streamlining and reorganising of departments to cut costs.
Raise taxes
The Minister could raise taxes, but that probably won’t yield much due to our slow rate of economic growth. So he might go for a rise in capital gains tax, but even that might not bring in much in these subdued economic conditions.
Borrowing large additional amounts just worsens the problem. Debt service is already one of the largest categories of government spending, and the fastest-growing. It also cuts into spending on categories like health, education, and investment in infrastructure which is positive for growth.
The real problem is that the ANC cannot restore fiscal stability and bring about big structural reforms because of the vested interests to which it is beholden. We are already suffering from the consequences of power cuts, transport disruptions and low economic growth. Let’s hope we do not have to pay the big price of a fiscal and financial crisis.
The views of the writer are not necessarily the views of the Daily Friend or the IRR
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