South Africa’s public finances are under pressure, with recent data suggesting the country is heading for a much larger than expected budget deficit this year as tax revenue declines while expenditure rises. To prevent a debt blowout, the provinces are being exhorted to cut costs by R25bn, despite the damage this could do to already hollowed-out health and education services.
In the past two budgets, the National Treasury topped up provincial budgets towards the end of the fiscal year by tens of billions of rand, partly to cover wage pressure. This was possible thanks to large revenue overruns, almost entirely as a result of the commodities boom.
But as commodity prices tumble, that situation has sharply reversed, and several economists are sounding a warning about South Africa’s deteriorating fiscal position.
HSBC economist David Faulkner notes that corporate tax receipts fell by more than 20% year on year in June (a drop of R26bn), while mineral royalties were down 40%, or R6bn, year on year. This, he says, reflects the impact of lower commodity prices and the squeeze on mining sector earnings.
At the same time, public spending continues to expand strongly. It was up 10% in the first three months of fiscal 2023/2024. This reflects a large increase in social grant payments and the wage bill, as well as a sharp rise in interest payments. The latter have absorbed 20% of revenue and 4.7% of GDP over the past 12 months, according to Faulkner.
This leaves South Africa’s year-to-date budget position at a R47bn deficit (compared with an R11.5bn surplus at the same time last fiscal year) and takes the 12-month rolling deficit to R369bn, 5.4% of GDP.
Granted, it is still early days, but this is almost R10bn worse than HSBC’s initial forecast for a main budget deficit of 5.1% of GDP. It is also a staggering R94bn worse than the Treasury’s February forecast of a main budget deficit of R275.4bn, or 3.9% of GDP.
In other words, on current revenue and expenditure trends, South Africa is headed for a deficit that could be R94bn larger than expected for the fiscal year as a whole.
Absa describes the outlook for the public finances as “fragile”. Given the combination of subdued GDP growth and falling export commodity prices, coupled with spending pressures from the public sector wage bill, Absa economist Miyelani Maluleke is expecting a main budget deficit of 5.2% of GDP (with Eskom’s debt relief accounted below the line).
BNP Paribas South Africa’s chief economist Jeff Schultz has just revised up his 4.5% main budget deficit forecast to 5.1%, noting that the spending run-rate this fiscal year far outstrips the average of the past decade.
“We always viewed the National Treasury’s February estimates as optimistic, particularly on spending,” he says. “Now, with some of these risks materialising into an election year, we deem it appropriate to flag the risks of a faster accumulation of debt over the medium term.”
Schultz expects the bulk of the fiscal deterioration to come from the expenditure side this year. He is concerned not just about the “chunkier” public wage bill, but also about the risk of more permanent social grant spending and the likelihood that troubled state-owned enterprises (SOEs), including possibly Transnet, will require additional state support.
He also says tax buoyancy will be lower on a more benign inflation outlook and softer corporate profits, especially from 2024 onwards. Relative to the Treasury’s February numbers, he believes the cumulative revenue undershoot over the next three fiscal years could be as high as R87bn.
The economy could be headed for an almost R100bn revenue shortfall in 2023/2024; provinces are being told to cut costs by R25bn
— What it means:
The deteriorating fiscal climate raises two key issues: how will the government respond to this fiscal picture, and how will the Treasury meet the heavier borrowing requirement?
The country’s fiscal challenges are a key reason for foreigners having been relatively aggressive net sellers of local currency debt over the past five years.
South African government bonds are now priced to deliver a just under 5% real return over the next 10 years. This suggests that investors have largely priced the required credit premium into local bond yields, says Sean Neethling, head of investments at Morningstar Investment Management.
In fact, except for the Covid-induced selloff in 2020, bond valuations are at their most attractive levels since 2014.
“Fiscal slippage is not new news, so it’s unlikely investors will significantly reprice new debt issuance by the National Treasury,” Neethling adds. “There is also an element of forced buying by local investors that can be expected to keep pricing relatively contained in the short term.
“The medium-term outlook, however, is less clear, particularly if the proceeds from increased debt issuance continue to be applied to funding consumption expenditure instead of tangible assets.”
The head of the Treasury’s budget office, Edgar Sishi, declined to comment other than to say that in the adjusted appropriation and medium-term budget policy statement in October the Treasury will outline the financial performance of departments and provide revenue updates for the current financial year as well as an update on the government’s debt financing programme.
Even so, much about the Treasury’s stance can be gleaned from the technical budgeting guidelines it recently issued to provinces for the 2024 medium-term expenditure framework.
The document says “the 2023 economic outlook has worsened, fiscal revenues are weaker than expected and the financing of the government borrowing requirement is under renewed pressure”.
It confirms that the Treasury’s medium-term fiscal strategy is still to achieve fiscal sustainability by reducing the budget deficit and stabilising the debt-to-GDP ratio.
The Treasury’s position remains that upholding budget allocations for infrastructure and other policy priorities while maintaining a sustainable fiscal stance will support economic growth. However, it concedes that “the materialisation of large risks requires a policy response”.
The foremost of these risks has already occurred; the 2023 public sector wage settlement exceeded the amount budgeted for by a whopping R35bn. Workers obtained a 7.5% salary hike while the Treasury budgeted for the country’s R700bn wage bill to grow by only 1.6% this year.
Granted, the Treasury has created a fiscal buffer by allocating R95bn to reserves over the medium term precisely to cover the strong likelihood of a wage-bill overrun, further SOE bailouts and the inevitable extension of the R36bn SRD grant.
Even so, at the time of tabling the 2023 national budget in February, the Treasury was banking on the economy growing by almost 1% this year — something which seems impossible now. The latest Bureau of Market Research (BMR) consensus is for real GDP growth of just 0.3% in 2023.
When faced with tough choices, there can be no greater priority than ensuring the education and health care of our citizens and protecting the most vulnerable among us
— Alan Winde
To prevent a debt blowout, the government could borrow more, hike taxes or cut expenditure — or combine all three in some way.
However, the Treasury acknowledges in its technical guidelines that its ability to raise debt against a stagnating economy is “limited”. It is also reluctant to hike taxes, noting that tax instruments “inflict a higher economic loss in a depressed economy”.
The Treasury concludes that the debt stabilisation strategy requires a reduction in expenditure. As such, it has instructed the provinces to absorb R25bn of the unbudgeted R35bn wage bill overrun.
It concedes this will require “significant trade-offs” in government spending. It exhorts provinces to identify substantial savings within their existing baseline expenditure budgets, restrict the filling of noncritical posts or reprioritise spending away from underperforming programmes.
Unfortunately, this likely means a continuation of the trend of the state employing fewer, better-paid workers at the expense of service delivery.
Because the most labour-intensive departments involve teachers and nurses, the wage burden falls largely on provincial health and education departments. In the past, when the state has pushed wage increases down to these departments without raising the compensation ceiling, they have responded by reducing headcounts and reallocating resources away from goods, services, capital and maintenance and towards compensation.
Wits University adjunct professor Michael Sachs says: “If they stick to their guns this year and refuse to add additional resources to accommodate the wage bill agreement, we are likely to see widespread failure and disruption of government services, especially health and basic education.”
He says it’s “highly likely” that several provinces will run out of cash and be unable to pay salaries for teachers, doctors and nurses at some point in the current fiscal year. To avoid this would require a dramatic curtailment of headcounts, perhaps through a complete moratorium on recruitment, he suggests, or extensive cuts to other inputs, such as medical supplies.
Western Cape premier Alan Winde is “deeply concerned” and says he will not accept a situation where the national government centrally negotiates a wage settlement only to deny the provinces the funds to service it.
“The scale of expenditure reductions being considered will fundamentally compromise our and other provinces’ ability to deliver critical frontline services,” he adds. “Our view is that expenditure reductions that harm basic, constitutionally mandated services are neither credible nor rational and would inflict severe and lasting damage to our service delivery platform.”
The solution to South Africa’s fiscal challenges, he says, is to introduce urgent pro-growth structural reforms and reconsider unsustainable policy commitments.
“When faced with tough choices, there can be no greater priority than ensuring the education and health care of our citizens and protecting the most vulnerable among us.”
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