As the government cobbles together a fiscal stimulus package to offset the effects of the coronavirus, fiscal policy experts warn that SA is heading into a debt trap — if it isn’t there already.
In a new paper, Philippe Burger and Estian Calitz, economics professors at the universities of the Free State and Stellenbosch respectively, show that huge public spending cuts will be required to stabilise the debt-to-GDP ratio at less than 80% over the coming decade. If these cuts are not made, the debt ratio will reach 100% on current policies, and keep climbing.
At the opposite extreme, the authors show that reducing the ratio to 50% — the level it was at just four years ago — would, in the absence of much higher growth, doubtless be "politically impossible", even if the task were spread over the next 20 years.
They conclude that SA’s debt ratio is likely to remain persistently high in the long run and that the government’s financial position is precarious. At worst, the country faces a looming debt trap.
The paper, "Budget 2020 and a Looming Debt Trap", published on the Econ3X3 web forum, was written before President Cyril Ramaphosa declared the Covid-19 outbreak a national disaster, and it does not factor in the disease’s potentially devastating economic effect.
"A shock to GDP such as the 2008 global financial crisis, or possibly the 2020 Covid-19 crisis, could easily cause the debt-to-GDP ratio to spiral out of control and resume its upward path," they warn.
The big omission from the 2020 budget was any modelling from the National Treasury setting out how it expects SA’s debt ratio to evolve over the longer term. Previously, it supplied a forecast for up to 2027/2028, but the current projection stops at 2022/2023, by which time the Treasury expects gross debt to be 71.6% of GDP — a full 10 percentage points higher than it is today.
Economists are highly sceptical as to whether the government will stay within even these bounds, as doing so will require that its plans — including a R160bn cut to wage bill growth — pan out perfectly in the face of fierce opposition from unions.
"I have very little faith in the government’s capability to meet its targets," says Cristian Maggio, head of emerging markets at TD Securities, from London. "Even in its most optimistic scenario [a reduction of future public wage increases, no fiscal slippage, and growth meeting the government’s projections] the debt-to-GDP trajectory heads upwards with no stabilisation for many years."
Owing to the Covid-19 outbreak, which risks tipping the world into a global recession more severe than during the 2008 global financial crisis, the Treasury’s 2020 GDP growth forecast will be missed by a very large margin.
"I think its long-term debt projections would have looked pretty ugly [at the time of the budget in February] even in the best-case scenario," says Maggio. "They would look nightmarish now."
The big question Burger and Calitz seek to answer is what happens after 2022/2023. Does the debt ratio continue climbing on its current trajectory to hit 100% by 2031? Or, if the goal is to stabilise the debt ratio before that, how would that be achieved?
They model four possible scenarios that could play out after 2022, assuming the existing medium-term budget framework, which covers the period until then, stays as is (see graph).
The starkest projection (the purple line) shows that if the government fails to reduce the current 2.6% primary deficit, and real economic growth remains stuck at 0.5%, the debt ratio will breach 100% by 2027.
"Such a scenario may materialise if the government only partially implements the R160bn slowdown in the rate at which the wage bill increases over the medium term," they write. "Failure to stabilise the debt ratio — that is, the failure to restore fiscal sustainability — would, in turn, also undermine investor and business confidence and thus the GDP growth rate."
The second scenario (the red line) represents roughly the trajectory SA has been on since 2013.
It assumes that economic growth improves to about 2% by 2025 and the primary deficit narrows to 1.5% — its average since 2013. However, this scenario is also fiscally unsustainable. It simply pushes out the deterioration in the debt ratio to 100% by four years, to 2031.
Scenarios three and four (the yellow and green lines) assume that economic growth improves to 2% and 2.5% by 2025 respectively, and that the government gradually eliminates the primary deficit, allowing the debt ratio to stabilise at about 80% between 2025 and 2027.
However, for debt to stabilise, even at these uncomfortably high levels, the primary balance would need to improve by 3%-4% of GDP by 2027, from -2.6% of GDP now. In 2020 rands, this would entail huge expenditure cuts of between R165bn (in scenario 4) and R220bn (in scenario 3) each year from at least 2023 onwards.
This is equivalent to 18% and 24% of the wage and goods-and-services bills combined. To put this in perspective, the government’s entire annual capital expenditure budget is only R163bn.
Therefore the researchers conclude that, in the absence of a sustained resurgence in economic growth, the government is unlikely to prevent the debt ratio from breaching 75% or 80%.
They ask whether SA is already in a debt trap. And if not, what can be done to escape what appears to be a rapidly looming one?
They describe a debt trap as a fast-rising debt ratio in an environment in which a government is unable to raise more revenue through increasing tax rates and/or reduce government expenditure to levels needed to ensure a stable debt ratio.
At first, when it is not clear whether a government is in a debt trap (the situation SA is in now), it is still able to sell bonds to finance its debt by offering higher interest rates, even though this will severely increase its interest obligations. However, as its debt burden keeps increasing, it will likely find it harder and harder to find buyers for its bonds.
"Ultimately, once it cannot find such buyers, the debt trap shuts. When it shuts, it leaves only two options: either the government monetises its debt (printing money to repay debt, which may have calamitous inflationary consequences), or it defaults, destroying its national and international credit reputation."
The researchers argue that there are only three ways for SA to stabilise the debt ratio. They rule out major tax hikes, as SA’s tax burden is already high compared with that of other emerging markets. Raising it further will only discourage investment, productivity and innovation.
Instead, they urge policymakers to focus on reducing the tax gap — the difference between optimal and actual tax collection. The tax gap comprises a policy gap (created by various tax allowances, which may be revised or terminated) and the compliance gap, which stems from tax evasion — a major focus of the SA Revenue Service (Sars) this year.
With little prospect of stabilising debt, the SA government's financial position is set to remain precarious in the long run
— What it means:
Judge Dennis Davis, who heads the Davis Tax Committee, believes up to R100bn continues to evade the tax net. He estimates "conservatively" that SA could net R50bn of this by cracking down on illegal activity and fixing Sars.
Second, government must ensure that public expenditure supports economic growth; is shifted from consumption (paying wages) to capital spending (building infrastructure); and is more efficiently deployed so service delivery improves.
Third, and most important, the government must slash spending. Burger and Calitz stress that the government’s proposed R160bn cut in the wage bill is not a net cut in government expenditure. In fact, it’s not even an outright cut in the wage bill — it’s just a cut in the projected increase in the wage bill.
In other words, while it would slow the pace at which the wage bill grows, the bill would still increase by R68bn between 2020 and 2021; government expenditure would still rise by R302bn over the next three years; and the debt ratio would still balloon from 61% to 71% in this period.
"Whether the SA government is heading for a debt trap depends on whether the government will be able to serve the national interest and not yield to the demands of labour unions to not cut the government wage bill," they conclude.
"Ultimately, there is no substitute for political will, leadership and agreement, on the part of both the government and the trade unions, to avoid a debt trap."
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