South Africa’s growth prospects have worsened substantially over the past few months and financing conditions have tightened significantly. The implications of this double whammy for the fiscus and service delivery are dire.
These are teased out in a new working paper — “Austerity without Consolidation: Fiscal Policy and Spending Choices in Budget 2023” — by Wits University adjunct professor Michael Sachs and fellow researchers at the Wits Public Economy Project (PEP).
In contrast to the National Treasury’s 2023 budget, which has the deficit shrinking and the debt ratio stabilising at 73% by 2025 (up from 71% now), the PEP expects the budget deficit to widen, pushing the debt ratio close to 80% by 2025.
The PEP’s fiscal outlook is much worse than the Treasury’s, mainly because it is based on recent consensus forecasts for economic growth, which put it close to zero for the coming year against the 0.9% assumed by the Treasury in February.
Finance minister Enoch Godongwana has conceded that the Treasury was “overoptimistic” in its initial GDP forecast and has expressed concern over the knock-on effects that severe load-shedding and Transnet Freight Rail’s operational difficulties will have on revenue collection this year.
The Treasury will update its growth and budget forecasts in October.
In addition, the PEP notes that financing conditions have tightened considerably in recent months as capital outflows have stabilised at higher interest rates, with South Africa facing an elevated country risk premium on top of global rate hikes.
The tightening of financial conditions probably reflects underlying fundamental factors, says the PEP, the most significant of which is the slowdown in growth. But it also notes that South Africa has alarmed the markets through its handling of the Lady R imbroglio and by being greylisted by the Financial Action Task Force.
Against this backdrop, the Reserve Bank recently added a new element to its risk matrix: “capital outflows and declining market depth and liquidity”.
Noting that the proportion of South African government bonds held by local institutions had increased from 58% to 75% over the past five years, the Bank has become concerned about the capacity of local investors to keep absorbing new issuances.
According to Rand Merchant Bank (RMB), there have been eight failed inflation-linked bond auctions this year where the Treasury hasn’t been able to place its full allotment due to weak demand, resulting in a borrowing shortfall of about R920m. Even so, RMB expects the local bond market to be able to fund the government’s R300bn annual debt requirements — for now.
The PEP paper concludes that global capital markets have effectively downgraded South Africa by an additional notch — a move that will increase the government’s financing costs. These worsening macroeconomic conditions are reflected in the PEP’s bleak fiscal outlook.
It is also based on more realistic expenditure assumptions than the Treasury’s. For instance, it assumes that the social relief of distress (SRD) grant will remain and grow by CPI over the next three years, exceeding by almost R4.5bn the Treasury’s back-pocket reserves.
South Africa’s debt ratio will be close to 80% of GDP by 2025 on current government policies and consensus growth projections
— What it means
The central issue, according to the paper, is that continuous austerity over the past decade has eroded the quality and value of public services on which the majority depend. However, despite intensifying austerity, the country is no closer to consolidating its fiscal position.
The main area of bloating — the public sector wage bill — may not have been cut as aggressively as the Treasury wanted, but the PEP estimates that in real terms government employees have on average experienced a 9% fall in their basic pay since the pandemic. This has been a key element in reducing overall expenditure growth to historically low levels.
“Unfortunately, despite having achieved a historic cut in government pay, and an unprecedented slowdown in spending growth, the goal of fiscal consolidation now seems more distant than ever,” they write. “This is because macroeconomic conditions unrelated to the budget have substantially worsened.”
The combination of slower economic growth and higher interest rates means that even deeper cuts in spending and/or tax hikes are now required to counterbalance rising debt service costs.
But is continued austerity really feasible?
The authors warn that further austerity — whether warranted or not — implies the further erosion of social services. They fear that further spending cuts could aggravate the country’s deep political fissures and worsen social unrest.
This is the crux of South Africa’s fiscal dilemma: to stabilise the debt ratio now would necessitate even larger and more harmful spending reductions, which would likely prove socially and politically implausible.
The other option is to hike taxes. Tax hikes would dampen growth further and have so far been largely resisted by the Treasury given the weakness of the economy. However, the PEP thinks there is room to remove tax breaks on medical aid contributions and retirement income, as these benefit the most affluent households. This would generate revenue equal to 1.5% of GDP.
It also says VAT may have to be raised to finance any new social spending, and that the government needs to consider imposing user charges on the non-poor’s use of public services and infrastructure.
This needs to go together, it argues, with a rethink of the local government system, which remains mired in a crisis of nonpayment that is shifting an ever-greater burden of financing onto general taxation.
The chronic fiscal squeeze, coupled with failing public services and growing debt, casts a gloomy shadow over the country’s development prospects
— Wits Public Economy Project
Another area that must be tackled is the “policy disarray” at the centre of government. This has resulted in a growing gap between its fiscal consolidation efforts and its expansive policy agenda, as reflected in policies such as free higher education, the SRD grant, and the intention to introduce National Health Insurance (NHI).
The paper lists several examples of policy disarray. For example:
- Three years after the introduction of the SRD grant, the government has still not decided whether it will form the basis of a more extensive basic income grant, opting instead for annual budget extensions and ad hoc regulation. The Treasury has notionally provided for the grant’s continuation in its unallocated reserve, thus keeping alive the prospect that the government’s commitment to its permanent extension could be reversed.
- The presidential public employment project seeks to place thousands of untrained teacher assistants in schools, even as funding for qualified teachers and textbooks is cut. The Treasury has not budgeted for the president’s pet project over the medium term even though it is supposed to be central to combating unemployment.
- The medium-term budget implies a significant contraction in the public health-care system, with cuts to spending on health-care workers, medical equipment, and hospitals’ operational budgets even as NHI funding is focused on the construction of new hospitals.
- Universities and colleges are having core funding and infrastructure finance cut while the minister of higher education remains committed to a programme of “massification”, which includes the construction of two new universities.
The upshot of this policy incoherence is that “the connection between budgeting and policymaking has become increasingly tenuous”, says the PEP. “Budget plans cannot but lack credibility where policy is incoherent.”
This mismatch must be fixed, argues the PEP, as it is damaging the credibility of the budget and, over time, will also erode the credibility of the Treasury and other fiscal institutions.
For instance, in 2022, the minister of finance tabled two adjustment budgets and two special appropriations later in the year. This legislation changed the initial budget framework substantially.
The PEP doesn’t argue against fiscal austerity per se, but it is against the sweeping, across-the-board cuts that have led to a reduction in the employment of nurses, teachers and police officers and a deterioration of the systems that support them.
It calls instead for spending cuts to be backed by explicit plans that protect front-line services and limit the fall in government employment. This means identifying which other programmes and services will have to be curtailed.
Sachs says this doesn’t mean that the government must choose among free higher education, or a basic income grant, or NHI — it means accepting the need for a fundamental redesign of government programmes to make them more effective and feasible.
“So, you don’t need to choose between NHI and a defence force — India and Ghana both have an NHI but it is much more limited than what’s on the table here,” says Sachs. “You’ve got to cut your suit according to your cloth.”
The danger is that if the government continues to lack clear policy direction or fails to reform the public sector, it will feed increasing resources into growing dysfunction.
“The alternative,” says the PEP, “is to add defunding to dysfunction, which could tip social systems over the brink of collapse.”
While public sector reform is essential, the paper concludes that South Africa will only succeed at stabilising the debt ratio if there is a sustained improvement in economic growth and an easing of financial conditions.
This, it says, will require fixing the electricity supply constraint, restoring critical export infrastructure, and implementing a clear and consistent growth plan.
For as long as GDP per capita continues to decline, the PEP holds out little hope that the country will manage to slow the regression in social and economic rights.
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