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A less aggressive fiscal consolidation than envisaged in June 2020

Graviton
| Market Forces

By Arthur Kamp, chief economist at Sanlam Investments

The National Treasury’s 2020 Medium Term Budget Policy Statement (MTBPS) sketches a bigger increase in the government’s debt trajectory, relative to the ‘active scenario’ published in the June 2020 Supplementary Budget. Gross loan debt is now expected to stabilise at 95.3% of GDP in 2025/26, relative to the Supplementary Budget ‘active’ scenario, which projected debt would stabilise at 87.3% of GDP in 2023/24. The new projection relies on the Main Budget primary balance (revenue less non-interest spending) improving from -R474.8 billion in 2020/21 (-9.8% of GDP) to a surplus by 2025/26.

Tax increases have generated less revenue than expected

This planned consolidation emphasises expenditure cuts, although raising government income through tax increases of R40 billion are also budgeted for from 2021/22 to 2024/25. Treasury pointed out that ‘recent tax increases have generated less revenue than expected, and evidence suggests that tax increases can have large negative effects on GDP growth’. Main Budget revenue does increase, though, from 22.6% of GDP in 2020/21 to 24.9% of GDP in 2023/24, as tax buoyancy improves as the economy recovers.

Government will cut expenses, but at a lower rate than expected in June

Meanwhile, the higher debt trajectory announced in the MTBPS, compared with the June 2020 Supplementary Budget active scenario, mostly reflects lower non-interest spending cuts. These amount to a cumulative R156 billion in 2021/22 and 2022/23 in the MTBPS, whereas the Supplementary Budget showed cumulative spending cuts of R233.5 billion over the same two years.

According to the MTBPS further cuts of R150.9 billion follow in 2023/24, indicating fiscal consolidation is back-ended with the Treasury relying on implementation of zero-based budgeting by the 2023 Budget.

At the same time, the expenditure cuts imply negative real non-interest spending growth over the next three years, while the ratio of Main Budget non-interest spending falls from 32.4% of GDP in 2020/21 to 26.4% of GDP in 2023/24. This drives an improvement in the Main Budget balance from a deficit of 14.6% of GDP in 2020/21 to a deficit of 7.3% of GDP in 2023/24, which is still wide.

No sharp cuts but SA needs to shift from consumption to capital expenditure

The guiding principles at play here appear to be, firstly, that the current state of the economy cannot bear a fiscal consolidation that is too sharp and, secondly, that to the extent spending holds up, there should be a shift towards capital expenditure away from consumption.

Critically, this implies a large part of the cut in government spending need to come from the government’s wage bill. The Treasury notes that it has budgeted for a public-service wage bill increase of 1.8% in fiscal year 2020/21, followed by an average annual increase of 0.8% over the 2021 medium-term expenditure framework period. Effectively, the Treasury has not allowed for implementation of the third year of the 2018 public sector wage agreement, while a wage freeze is proposed for the next three years.

The fiscal authorities are trying to adhere to the age-old adage that if a state borrows, it should borrow to fund the acquisition of capital assets and not to consume. In so doing, the Treasury is stressing the importance of improving the government’s balance sheet. In pursuing fiscal consolidation it is important to reduce budget deficits and debt ratios. But, in the end, a fiscal consolidation without an improvement in the state’s balance sheet is an illusion.

Weakened SOE balance sheets put the Budget at risk

With the future for economic activity so uncertain, a long, arduous fiscal consolidation implies material risks to the outlook. Improved tax administration or proceeds from the sale of non-core assets represent potential upside risks, but this is arguably dwarfed by downside risks such as uncertainty around the ability to stick to the wage bill projection. Further, although the Treasury indicated the additional R10.5 billion allocated to SAA will be funded through reductions to the baselines of national departments, public entities and conditional grants, weakened state-owned entity (SOE) balance sheets and the large amounts of SOE debt, which the government has guaranteed, continue to lurk as significant risks. Indeed, the Treasury notes that the government’s guarantee portfolio amounted to R693.7 billion in March 2020, mostly granted to Eskom (R350 billion). By end-March 2020, R583.8 billion of these government guarantees had been utilised. Further, the MTBPS indicates that over the next three fiscal years, guaranteed debt redemptions are expected to average R35.6 billion, compared with R27.5 billion in the last year.

Private sector investment is being crowded out

The past decade has shown that as government expenditure has increased relative to total expenditure in the economy the potential economic growth rate has slowed. One key reason for this is that the government’s large budget deficits imply the state is absorbing more and more of the available domestic resources. At the same time the continuous sovereign debt rating downgrades, which have accompanied SA’s deterioration towards fiscal failure in recent years, have placed material upward pressure on domestic real interest rates. These factors have effectively crowded out private sector borrowing and investment. Ultimately, one can observe from the history of numerous countries that excessively high government debt levels slow potential economic growth.

This is unlikely to change anytime soon. Although the government’s borrowing requirement falls to R602.9 billion in 2021/22 (compared with the June 2020 estimate of R560.5 billion), from R774.7 billion in 2020/21, it remains high. Moreover, the borrowing requirement increases to R637.2 billion in 2022/23, partly reflecting higher redemptions.

The low effective nominal interest rate on government debt, expected at around 6% (in nominal terms) in the current fiscal year, is helpful.  But, this partly reflects a high level of short-term debt issuance. There are limits to this and pressure can be expected to mount in the medium to long term as more and more maturing debt is issued at higher interest rates.

Overall, South Africa’s fiscal situation, which implies high levels of government borrowing over the medium term, continues to highlight the importance of foreign capital inflows to supplement domestic savings and grow the economy. Without increased growth, the planned fiscal consolidation is not plausible.

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