The debt stabilisation path outlined in finance minister Tito Mboweni’s supplementary budget, and to which the cabinet has agreed, exceeds the demands typically made in International Monetary Fund (IMF) adjustment programmes and is simply not feasible.
This is the conclusion of an analysis by University of the Free State economics professor Philippe Burger. It adds to the chorus of voices arguing that Mboweni’s plan is too aggressive to be credible and is unlikely to be achieved.
The centrepiece of the budget is to get debt to stabilise at less than 90% of GDP in three years. To achieve this will require a R250bn adjustment, mainly through cutting expenditure, in combination with deep economic reforms to reignite growth.
It’s a very tall order. To put the R250bn in perspective, all SA’s fiscal consolidation efforts since 2014 have shaved just R70bn off expenditure. It would also require SA to run a primary budget surplus, which is something it has not achieved since 2008, when there had been a long commodity boom.
Given that SA is in the grip of the worst recession since the 1930s — one that is set to permanently scar the economy — there is deep scepticism about whether such extensive cuts are politically or economically feasible.
Both Moody’s and Fitch have serious reservations about the plan. Fitch, which in April cut SA’s foreign currency rating again, taking it two notches into junk territory with a negative outlook, has even hinted that a further downgrade could be on the cards.
It notes that "powerful trade unions and deep divisions within the governing ANC" present a significant hurdle to the planned expenditure cuts, which it believes are "unlikely to be achieved". For instance, it points out that the government still hasn’t managed to reach agreement with unions on the wage bill savings included in the February budget.
Burger’s analysis shows that not even the IMF would be likely to impose such an aggressive fiscal consolidation plan on SA. He believes that getting the debt ratio to stabilise anywhere below 100% will be "too tough a path to walk", and that SA is likely to be stuck with an extremely high debt ratio for at least the next 10 to 15 years — a prediction that comes with worrying economic implications.
Mboweni presented just two possible scenarios in the supplementary budget — an active and a passive one — showing what could happen to SA’s debt ratio after the Covid-19 crisis with or without intervention.
The passive scenario is simply a continuation of SA’s current, unsustainable fiscal trajectory, assuming no further adjustments are made. It shows the debt burden spiralling inexorably upwards to 140% of GDP by 2028/2029. According to Mboweni, this would depress growth, inviting a sovereign debt crisis that would unravel all the social gains SA has made over the past 26 years.
The active scenario, which would involve a drastic fiscal adjustment, has the debt burden peaking at 87.4% in 2023/2024, after which it gradually falls back towards 70% by the end of the decade (see graph).
Given these two choices, the cabinet has duly endorsed the active scenario. Mboweni has undertaken to reveal the precise budget cuts and economic reforms required to achieve it in his medium-term budget policy statement in October.
The problem is that the cabinet is likely unaware of just what it has agreed to and, anyway, has a poor track record of sticking to fiscal or savings targets imposed by the National Treasury. Given the choice between coughing up or staring down striking public sector workers and denying bail-outs to delinquent state-owned enterprises, it has nearly always chosen the easier option. Mboweni’s budget shows there are no easy options left if SA wants to avoid a debt crisis.
However, achieving the active scenario will require SA to turn the primary deficit of 9.7% of GDP which SA is running because of the pandemic into a primary surplus virtually overnight.
Over the past decade, SA has run an average primary deficit of 1.6% annually and, in February, it abandoned the target of achieving a primary budget balance (excluding Eskom support) by 2023/2024.
The primary balance is the difference between revenue and noninterest expenditure. This means that SA, a heavily indebted country where the real economic growth rate (about 1%) is far lower than the real rate of interest on debt (about 5%), has to run primary surpluses to prevent debt from continually rising.
The supplementary budget seems at odds with this requirement. It allows SA to keep running primary deficits for the next two fiscal years. At the same time, it projects that the debt burden will remain flat at about 82% this year and next, only increasing to 86% in 2022/2023.
By contrast, Burger shows a 2% primary surplus will be required as early as next year to achieve the active scenario. And he shows that even in a normal year, without the exceptional impact of the Covid-19 crisis on the primary balance in 2020/2021, SA would have needed to make an adjustment equal to 3.6% of GDP to move from a 1.6% deficit to the 2% surplus.
This is close to the average adjustment of 4% seen across most IMF adjustment programmes.
This is all well and good, though the cabinet will probably be shocked to discover it has just agreed to terms not dissimilar to those that might be imposed under an IMF structural adjustment programme.
But to keep SA on the active-scenario path, Burger estimates that the primary surplus will have to rise to 7% over the coming five years, assuming inflation of 4% and a 9.2% nominal interest rate — and that economic growth improves in line with Mboweni’s projections, reaches 2.5% by 2026/2027 and stays there.
This would far exceed requirements of typical IMF adjustment programmes and is, he believes, "simply not politically or economically sustainable".
Moreover, he says: "Even though a reduction in government expenditure might in general release resources for investment and be supportive of economic growth, this large an adjustment might dampen economic growth merely by being a drag on aggregate demand. This, in turn, might render the policy self-defeating."
To find a more realistic adjustment path, Burger considered what would be required to get debt to stabilise at 100% of GDP. The "stability scenario" (the blue line in the graphs) demonstrates this path, based on the same macroeconomic assumptions as before.
Under this scenario, the primary balance would need to improve to only 2.5% of GDP by 2026/2027 and stay there. Though more realistic, Burger thinks this scenario would still require tough action and commitment from the government.
Finally, he posits a "consolidation scenario" (the green line) which shows that once the debt ratio reaches 100% SA would have to achieve 3.5% real GDP growth rates, something not seen since the mid-2000s, and sustain 4.5% primary surpluses, to get it back to the 60% debt level budgeted for before the pandemic.
Burger’s conclusion is that after a decade of unsustainable fiscal policy, followed by the pandemic, it is unlikely that SA’s debt ratio can be stabilised at any level below 100%, as doing so will simply require too aggressive an adjustment.
But even if the government chooses a less ambitious option and succeeds in stabilising the debt ratio at 100%, it is unlikely that it will get the ratio to fall significantly from that level. In short, SA is likely to remain stuck with an extremely high debt ratio for at least the next 10 to 15 years.
Burger identifies three chief implications from his study. The first is that the government will have little room to borrow to finance President Cyril Ramaphosa’s big infrastructure push.
This means his post-Covid investment-driven growth strategy will require a strong public-private partnership model, where the private sector builds, operates and finances more than 15% of all public infrastructure, compared with about 2% now.
Second, there will be little room for fiscal policy to play a countercyclical role to soften the impact of future recessions.
"Fiscal policy has run out of bullets," he says. "If SA manages to stabilise the debt ratio at a high level, just preventing future recessions from causing it to spiral out of control again will take careful planning."
Third, the full burden of countercyclical policy will fall to monetary policy. However, the Reserve Bank will be limited in the extent to which it can ease monetary policy by the high-risk premium attached to SA’s high debt ratio and junk credit ratings.
The deep irony of SA’s situation is that the reason Mboweni is budgeting so aggressively for debt stabilisation is that he needs to unlock billions in low-cost loans from the IMF and other multilateral funders, and they cannot, by law, lend to fiscally unsustainable entities.
The bottom line is that SA has left it too late to get its house in order; after years of living large, the degree of fiscal austerity required to stabilise the debt ratio has become so huge it could throw the economy into reverse, and ultimately prove self-defeating.
Mboweni is right: SA’s "fiscal reckoning" has finally arrived.
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