CLAIRE BISSEKER: SA economy is a house aflame

The medium-term budget policy statement was bad enough. But the National Treasury’s fiscal risk statement, which was appended to it but largely ignored when it was released, shows just how much worse things could get.

It concludes that SA’s fiscal risk outlook has "deteriorated sharply" and that SA’s public finances are "highly vulnerable" — Treasury-speak for "Watch out, the house is on fire!"

The Treasury has three main concerns: the risk that the economy underperforms, leading to even weaker revenue collection; the danger that state-owned enterprises (SOEs) fail to reform, further draining public resources; and the risk that provincial and municipal finances deteriorate further, translating into even bigger accruals and unpaid bills.

Over the past nine budget cycles, the Treasury has overestimated GDP growth every year. Its current baseline forecast is for long-term real GDP growth to average 2.2% and the debt-to-GDP ratio to rise steadily to 80% by 2027/2028 from 60% now, unless there are further budget cuts or tax hikes.

The risk statement offers two alternative scenarios, in which SA does either a little worse or much better than this baseline expectation.

In Scenario A, titled "Insufficient reforms", SA experiences a sustained economic contraction in 2020, leading to larger revenue shortfalls that have far-reaching effects on service delivery and cause the debt ratio to hit 85% by 2027/2028 (see graph).

In Scenario B, "Stronger domestic growth", the economy rebounds to average growth of 3% over the medium term and the debt ratio stabilises inside 70% by 2025/2026.

"[These scenarios] paint a fairly dramatic picture that emphasises how crucial it is to achieve faster GDP growth and the large impact that this has on the debt trajectory," says Bureau for Economic Research chief economist Hugo Pienaar.

They show that growing just one percentage point faster will have a notable effect on SA’s debt metrics. However, even with 3% real growth, debt will still climb towards 70% of GDP.

This implies that growth would need to be even faster — closer to 4% — to prevent debt from rising from current levels, says Pienaar. It also shows that even a 3% growth scenario will require expenditure cuts and/or tax hikes and/or asset sales to prevent debt from rising towards 70%.

Citibank economist Gina Schoeman says that, given the political will that would be required to achieve Scenario B or the Treasury’s target of stabilising the debt ratio over the next five years, she expects the actual outcome to approximate Scenario A.

The Treasury is also not hugely optimistic about the prospects of SA staging a growth recovery, having reduced its average medium-term growth forecast from 1.7% to 1.1%, and its average long-term forecast from 2.4% to 2.2%.

But there is some good news. According to the Treasury’s updated long-run fiscal model, as long as the country sustains a long-run growth rate of 2%-2.3%, it should be able to afford social grants, even as the population climbs to 76-million over the next 20 years.

Though grant beneficiaries will grow from 17.9-million people now to 22.5-million over this period, spending on social assistance is expected to remain relatively stable at 3% of GDP. This is a key finding, given the role social grants play in alleviating poverty, reducing inequality and keeping a lid on social discontent.

Eventually, the only option left is to reduce headcount by slowing the intake of new recruits and leaving key positions vacant

—  Michael Sachs

However, the main message implicit in the model — and the reason it was initially introduced by former budget office head Michael Sachs in 2014 — is to demonstrate to politicians that they have to make choices between various unfunded policy options. They cannot have their cake and eat it.

The bottom line is that SA will not be able to pay social grants, fully introduce National Health Insurance (NHI) and progressively roll out comprehensive free tertiary education over the next 20 years unless the economy grows faster than 2.3%. The Treasury estimates that NHI, if fully adopted, will push public health spending from 4% of GDP now to possibly as high as 6% by 2040 — a proportional increase of 50%.

Over the same period, university education costs will rise from 1.4% to 2% of GDP (a proportional rise of more than 40%) if the policy of fully subsidised higher education is rolled out as intended. Once fully implemented, between 50% and 60% of undergraduate university students and all those at technical and vocational colleges are expected to be fully subsidised.

The Treasury’s estimate assumes a continuation of the historic trend of higher-education costs outpacing inflation, largely because of above-inflation wage increases. It concludes that it if this trend continues it will be "difficult" to sustain a comprehensive, fully subsidised higher education policy.

However, if the fees policy is more closely aligned with consumer inflation, it should be possible to keep university education spending to 1.5% of GDP by 2040.

According to the Treasury, the department of higher education & training is developing a more sustainable policy, in consultation with tertiary institutions.

One of the more alarming revelations in the fiscal risk statement is that SA’s debt redemptions are set to increase sharply — to almost R100bn a year on average over the next decade (see graph).

If the government continues to roll over maturing debt, this will place "substantial pressure on domestic capital markets, raising borrowing costs across the economy", it warns, adding that for every 10% rise in interest rates, SA’s debt service costs will rise by more than R5bn.

"The government would continue to finance its borrowing requirement, but at a greater cost," explains the Treasury. "SOEs, however, would likely struggle to refinance existing debt or issue new debt."

The Treasury acknowledges that it has become increasingly difficult for SOEs to obtain access to funding in capital markets over the past few years due to their poor financial and operational performance and unsustainable debt servicing costs. As a result, many are repeatedly requesting guaranteed lines of credit from the government.

The government’s guarantee portfolio topped R683bn in March, with R350bn of that granted to Eskom. So far, more than R372bn of these guarantees has been used, putting government’s exposure at a whopping 7% of GDP.

In the Treasury’s view, these high contingent liabilities pose the second-biggest risk to the fiscus after weak growth. It says they will continue to grow as long as Eskom and other SOEs fail to implement extensive governance and operational reforms.

Unpaid bills or accrued debts from provincial and local governments pose the third-biggest risk to SA’s fiscal sustainability.

Mounting accruals reflect poor financial and supply chain management, but they also reflect the fact that, though the Treasury has imposed hard ceilings on total expenditure, the government has simultaneously allowed the public wage bill to balloon and has kept extending government services.

The upshot is that spending cuts have been pushed down to lower levels of government and been obscured in the erosion of public infrastructure and basic services. These hidden costs are now popping up all over the place — in the R100bn in medico-legal claims against crumbling provincial health departments (up from R80bn in 2017/2018) and in the billions that dysfunctional municipalities owe Eskom.

"Faced with hard budget ceilings, a rising salary bill and a blizzard of new priorities, departmental finance managers are left to square the circle," says Sachs in a forthcoming paper in New Agenda: South African Journal of Social and Economic Policy.

"Some are able to shift the problem off-budget onto other departments, spheres of government, SOEs or public agencies. This leads to rising payment imbalances across the public sector."

For instance, departments owe rates and service charges to local government, which in turn fails to pay electricity and water bills, contributing to the financial distress of Eskom and regional water boards. These agencies then lobby the government for bailouts.

According to the Treasury, uncollected revenues due to municipalities grew 17% to almost R148bn between fiscal 2017 and fiscal 2018, while overdue amounts owed by municipalities grew by more than 52%, from R23bn to R36bn. Half of this amount is owed to Eskom.

Last week, President Cyril Ramaphosa had to intervene to stop Eskom from cutting power to commuter trains over the Passenger Rail Agency’s unpaid bill, which reportedly runs into hundreds of millions of rands.

But this is just the start, says Sachs. As financial pressure mounts, liabilities are passed on to government’s suppliers, maintenance budgets are cannibalised and salaries are funded with resources intended for capital, research, systems improvement or skills development.

"Eventually, the only option left is to reduce headcount by slowing the intake of new recruits and leaving key positions vacant," says Sachs.

"The result is lengthening queues in hospitals, bigger class sizes in schools or a failure of crime prevention."

If the situation is not arrested, SA will continue to erode its developmental gains and spiral downwards into a debt trap.

Perhaps, as a first step, the Treasury should attach its fiscal risk statement to the front of the budget instead of the back from now on.