South Africa’s public finances are taking strain, and in the absence of a credible growth strategy concerns are growing about the country’s longer-term debt sustainability.
Some left-leaning economists at the Institute for Economic Justice (IEJ), a private think-tank in Gauteng, dismiss the idea that there is a crisis. They accuse the National Treasury, which is trying to slam on the spending brakes, of “stoking panic” so it can force through unpopular expenditure cuts.
Unfortunately, the consensus is that everything is not fine. While nobody thinks South Africa is facing an imminent fiscal crisis, it is clear that unless the Treasury alters the fiscal path the country is on — something it has failed to achieve despite a decade of fiscal consolidation — the debt ratio will just keep rising, inviting a funding crunch.
What nobody disputes is that South Africa will miss its 2023/2024 budget targets by a mile, given the likelihood of revenue undershooting requirements by at least R50bn on softer commodity prices, weak growth and load-shedding and logistics failures.
Expenditure is set to overshoot the Treasury’s unrealistic February budget estimates by a roughly equal amount as higher interest rates, continued state-owned enterprise (SOE) losses and a larger than expected wage-bill settlement have upended Treasury’s forecast.
This means the main budget deficit is set to widen to about 5.2% of GDP in 2023/2024 (vs the target of 3.9%). This is bad enough, but the really scary number is the gross borrowing requirement, which includes the R254bn Eskom bailout and R516bn of maturing domestic and foreign loans over the next three years. At the current run rate it is likely to exceed R600bn, or 8.5% of GDP, in 2023/2024.
This would be substantially bigger than previous levels in the past 20 years. The only time it was larger was during Covid, when it reached R618bn, or 11% of GDP, given the hit to growth from the pandemic (see graph).
With debt service payments already close to 20% of GDP and the South African government bond (SAGB) market starting to show some signs of indigestion, finding the funding in the absence of a credible growth story is becoming a challenge.
Krutham MD Peter Attard Montalto doesn’t think people grasp “how close to the edge” the SAGB market is given the reduction in foreign appetite and liquidity, and the extent to which high interest rates are crowding out other spending. The upshot is that the Treasury dare not push issuance any higher.
In the short term, Attard Montalto expects the Treasury to avoid increasing SAGB issuance and rather make up the funding shortfall by seeking a soft megapolicy loan from the World Bank and/or issuing more US dollar bonds.
“So, no, I don’t think the National Treasury is forcing panic,” he says. “They know there will be a need to panic at some point if things aren’t arrested here ... and, given the risks of slow slippage year by year, they’re right to sound alarm bells.”
Sanlam group economist Arthur Kamp argues that an imminent fiscal crisis is unlikely given South Africa’s deep and liquid capital markets, the long maturity structure of government debt and the Reserve Bank’s credible inflation-targeting regime. However, he warns that these strengths can only carry us so far: “Absent an adjustment to our fiscal dynamics we are firmly on course for an unwelcome fiscal endgame.”
HSBC economist David Faulkner has also been ringing alarm bells. He expects the country’s debt ratio to shoot up from 71% now to 80% by 2025/2026, owing to his scepticism that the government will be able to rein in spending and shore up revenue, especially with an election looming.
He puts the total funding requirement at R610bn (8.6% of GDP) this fiscal year, exceeding the government’s current funding plans by about R115bn. But, given the prospect of lower tax receipts on a sustained basis and structurally higher spending, he fears that the funding requirement will keep climbing — to R640bn in 2024/2025 (8.7% of GDP) and R750bn in 2025/2026 (9.5% of GDP).
If he is correct, this suggests that even as load-shedding worries ease and growth starts to recover, there will be increasing concerns about South Africa’s longer-term debt sustainability.
South Africa could soon face a funding crisis if it cannot reform the economy to get growth going
— What it means:
The country’s underlying fiscal problem is that spending and interest rates are too high relative to the slow pace of GDP growth. This is why the debt ratio has kept climbing even though the Treasury has been tightening the spending screws for several years.
With tax hikes being almost inconceivable given the lack of growth, and the option to increase borrowing being limited by the high risk premium on government debt, even harsher fiscal austerity — including deeper cuts to the wage bill — is now called for.
The Treasury is trying to limit hiring, delay infrastructure spending and force cost-cutting at all levels of the government. It also wants to ditch some of the big-ticket items that it hasn’t budgeted for beyond the current year, including the R350 a month social relief of distress (SRD) grant and the presidential employment initiative.
The problem is that deeper fiscal austerity, though necessary to halt the unsustainable build-up of debt, will further erode service delivery. With unemployment and poverty high and rising, there is a compelling need to retain (and even raise) pro-poor spending, making it politically difficult to force expenditure cuts through ahead of next year’s election.
“In exaggerating a ‘crisis’, the National Treasury is able to force through chaotic, dire and ultimately deadly austerity measures across the board,” says IEJ researcher Zimbali Mncube. “This will undermine progress made towards realising socioeconomic rights, ... stifle economic growth and job creation and exacerbate the extreme hardship experienced by millions of people for years to come.”
Aware of the lack of political space, most economists are factoring in the permanent extension of the R34bn-R40bn SRD grant and allowing for continued SOE bailouts of about R24bn a year, based on past experience. Most are, however, not yet factoring in the potential cost of National Health Insurance, which preliminary Treasury costings put at an initial R40bn a year.
If the Treasury’s preferred cost-containment efforts are blocked it may have little option other than to slice a fixed percentage off the budgets of all departments — a desperate, inefficient way of slowing spending.
But even then, it’s difficult to see how there can be much improvement in the budget balance in the absence of faster growth, a widening of the tax base and the lowering of debt service costs — issues that depend on accelerated structural reform.
“It’s going to be difficult to find space for deep and durable expenditure cuts,” says Absa economist Miyelani Maluleke. “Similarly, it’s not clear that there are many tax levers left that can raise a significant amount of revenue without hitting economic growth. So, difficult as it is, finding a way to lift economic growth by accelerating the kinds of reforms that we have seen under Operation Vulindlela must also be part of the solution.”
Kamp expects the Treasury to succeed in getting the primary budget balance (revenue minus noninterest expenditure) down to about 0% over the next two years, but notes that large primary surpluses will be required to stabilise the debt ratio, even if real GDP lifts to about 2%.
Given South Africa’s various strengths and buffers (including the R100bn earmarked for the unallocated and contingency reserves over the next three years), the country is probably not facing an imminent sovereign debt rating downgrade.
“But if we don’t come up with a credible plan to stabilise the debt trajectory, it’s likely to be only a matter of time before this happens,” says Kamp. “That would signal a significant further increase in fiscal risk, which would in turn likely maintain upward pressure on real interest rates, reinforcing our fiscal problem.”
Absent an adjustment to our fiscal dynamics we are firmly on course for an unwelcome fiscal endgame
— Arthur Kamp
So, what would such an overarching plan look like?
The IEJ would raise direct taxes (including on corporates and people earning more than R750,000), institute prescribed lending and lower interest rates, among other things that would roil the markets and hurt growth. It is vehemently opposed to an increase in the VAT rate, arguing that this would hit the poorest the hardest.
Kamp would favour a plan that restrains wasteful consumption spending, shifts the composition of spending towards infrastructure, reviews government subsidies and moves away from direct taxes (such as personal and corporate income tax) to indirect taxes such as VAT, which studies show would do less harm to growth than other taxes and, given zero-rating and exclusions, need not be regressive.
Treasury director-general Duncan Pieterse is not in favour of tax hikes, saying in a recent interview with the FM that South Africa “must avoid tax increases as far as possible” but, if they are unavoidable, be clear about the trade-offs for growth, tax morale and employment.
The bottom line is that the country has backed itself into a fiscal corner — and it won’t be able to extricate itself without making tough choices that involve imposing some pain somewhere. Just where, is the question the medium-term budget policy statement will have to answer on November 1.
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