ARTHUR KAMP: More money in the coffers does not mean spending cuts fall away

Finance Minister Enoch Godongwana is likely to show a substantially improved fiscal position in Thursday’s 2021 medium-term budget policy statement relative to previous projections. We expect main budget revenue to exceed the initial estimate by R130bn (2% of GDP) in 2021/2022, reflecting the positive effect on domestic income of high export commodity prices. 

Budget deficit forecast for next two years is much improved

There is a material degree of forecast risk, since the fiscal year still has some way to run. But assuming the one-off cash payment (R20bn) to government employees in 2021/2022 is “deficit neutral”, while including the additional spending announced after the July 2021 protests, we expect a main budget deficit of -6.3% of GDP in 2021/2022, followed by -5.6% in 2022/2023.

This is far better than the projections published by the Treasury in February 2021, which forecast main budget deficits of -9.0% of GDP and -7.4% of GDP for 2021/2022 and 2022/2023 respectively. A significant part of the improvement in the ratio reflects recent data revisions though, which revealed that GDP was significantly larger than previously estimated.

A smaller budget deficit implies the government’s gross loan debt ratio should decline, possibly to a shade below 70% of GDP at end-March 2022 from 70.7% at end-March 2021. This helps reduce near-term sovereign debt ratings risk, though looking ahead, higher real per capita income and a clear path towards stabilising (and ultimately lowering the debt ratio) remains imperative.

At the same time, the primary budget balance (revenue less non-interest spending) is expected to improve from a deficit of -1.9% of GDP in 2021/2022 to -0.9% of GDP in 2022/2023, before switching to a small surplus of 0.3% of GDP in 2023/2024. This assumes the fiscal consolidation path plotted in February 2021 remains intact, except for additional social grant spending, which we have pencilled in at about 0.5% of GDP. 

With dismal levels of unemployment, social grants need to keep up with inflation

The better-than-expected fiscal position raises the question as to whether there is room to spend more given the country’s depression-level unemployment rate of 34%. There is a strong argument that social grants spending should be maintained in real terms, or increased, and it remains to be seen to what extent the Treasury lends support in the years ahead.

However, additional spending on marginalised citizens (over and above maintaining current social grants spending in real terms) requires expenditure cuts elsewhere. SA still requires fiscal consolidation. Why? Even though the fiscal position has improved, the government’s financing requirement remains large. Initially, in February 2020, a financing requirement of R545bn (including redemptions) was projected for 2021/2022 — to be funded through gross domestic and foreign debt issuance of R435bn and use of the government’s cash balances.

A revised financing requirement of R450bn is now expected. Even so, this amounts to 7.4% of estimated GDP. Further, given large government loan redemptions in 2022/2023, in addition to the budget deficit projected above, a borrowing requirement including redemptions of R512bn is expected in 2022 (7.9% of GDP). 

Government borrowing is crowding out private sector investment

The flipside of this development is material crowding out of private sector investment. SA Reserve Bank data shows private sector net capital formation (gross capital formation less consumption of fixed capital) fell R76.3bn in 2020. This is the first outright fall in a calendar year since the 1980s. Private sector fixed investment has been constrained by electricity shortages and policy uncertainty, but the government’s large borrowing requirement, which has contributed to upward pressure on real interest rates, is a major contributing factor too.

In addition, government spending has been skewed towards consumption at the expense of capital expenditure, so the associated expenditure multipliers have been weak. This has added to the steady deterioration of SA’s potential growth rate.

New debt continues to be issued at high real interest rates

The problem is new debt continues to be issued at higher real interest rates than the current potential growth rate in real GDP. And though the government debt ratio is expected to be relatively stable in the near term, the expected improvement in the primary budget balance is not sufficient to prevent the government’s debt ratio from continuing to increase over time.

Admittedly, the projected longer-term trajectory of the debt ratio is relatively flat compared with the past decade. But here’s the thing: significant fiscal consolidation execution risk lingers. To achieve the projected improvement in the budget balance above, the government’s total expenditure must decrease by about 2.25% of GDP between 2021/2022 and 2023/2024. This is not easy to achieve given current demands on the government’s resources. It implies the Treasury needs to stick closely to its intended government wage bill restraint. Meanwhile, a lift in potential real GDP growth, sufficient to stabilise the debt ratio, is not guaranteed.

Moreover, the budget read in February 2021 included provisional allocations to state-owned companies of R21.9bn and R21bn in 2022/2023 and 2023/2024. However, additional allocations to state-owned companies, in aggregate, seem likely.

The easy gains might be behind us

In any event, it’s not good enough to merely stabilise the debt ratio. After all, a business cycle downturn is likely at some point. The easy gains from the positive terms of trade bounce have probably been made in the current fiscal year, as real GDP growth projections for 2022 reflect a slowdown to about 2% from about 5% in 2021.

In the end, stronger growth alongside expenditure restraint is needed to make the fiscal maths add up. The way to achieve this is to lower the government borrowing requirement to create the “space” for private sector borrowing and investment, while continuing with economic reforms to improve the business environment and the ease of doing business.  

• Kamp is chief economist at Sanlam Investments.