Finance minister Tito Mboweni. Picture: WALDO SWIEGERS/BLOOMBERG
Finance minister Tito Mboweni. Picture: WALDO SWIEGERS/BLOOMBERG

On October 30 finance minister Tito Mboweni will unveil the medium-term budget policy statement. This provides an update on budget performance in 2019 and critically also sets new revenue and expenditure targets for the next three fiscal years.

Mboweni, who was appointed just a little over a year ago, is having to grapple with the uncomfortable reality that SA has a serious fiscal problem with no easy solutions, no leeway to postpone tough decisions and no broad social or political consensus on what needs to be done. Thus, this medium-term budget policy statement represents something of a fiscal Rubicon for the country.

How did we get here? Since the financial crisis a decade ago SA has followed a countercyclical fiscal policy, running big budget deficits in the expectation that eventually GDP growth would recover and generate a bounty of tax receipts to fund debt repayment. However, a decade’s worth of persistent growth disappointments, combined with the damage of state capture at the SA Revenue Service (Sars), have weighed on the buoyancy of tax collections, which the government has offset by hiking tax rates a lot over the past few years.

Meanwhile, public spending has continued to ratchet up steadily, due in part to rising numbers of public sector workers, who regularly enjoy above-inflation pay increases, and more recently to bailout payments to state-owned companies. For example, Eskom is to get a transfer from the fiscus of about 1% of GDP per year. All this has left SA with larger budget deficits than ever. We forecast the main budget deficit will be at least 6.1% of GDP in 2019, and possibly higher. Public indebtedness has more than doubled from 26% of GDP in 2008/2009 to over 59% of GDP now (our forecast).

These deficit and debt numbers may not sound terrifically big to the average South African. However, the arithmetic of debt dynamics — the way a country’s debt burden evolves in response to the budget deficit, inflation, the exchange rate and growth — is alarmingly relentless. When the real (inflation adjusted) interest rate at which a country borrows exceeds real GDP growth, the country needs to run a primary budget surplus to stabilise the debt ratio.

However, we are nowhere close. With our budget deficit of about 6% of GDP in 2019 and interest payments on government’s debt of about 3,5% of GDP, SA is now running a sizeable primary deficit of about 2.5% of GDP, against real GDP growth of about 0.5% in 2019. Thus our debt burden looks set to continue growing strongly. The longer adverse debt dynamics are allowed to run, the more slippery they become.

One approach is to bite the bullet and tighten the fiscal stance further, either by raising taxes or by cutting spending. However, this is a direct hit to aggregate demand, and could weigh on GDP growth in the short run.

Why does it matter? Higher government borrowing pushes up interest rates across the board, crowding out private sector spending. However it also means more of the scarce taxes collected must be spent on debt service, leaving less money available for everything else. Already interest payments on the government debt are the fastest-growing item in the budget, with projected growth of nearly 11% per annum over the next three years. On the current trajectory the government’s debt service costs will overtake its spending on social protection in 2020/2021.

What can the government do in the face of such challenging debt dynamics? Unfortunately, while there are obvious answers from an economist’s perspective they are rarely politically palatable. One approach is to bite the bullet and tighten the fiscal stance further, either by raising taxes or by cutting spending. However, this is a direct hit to aggregate demand, and could weigh on GDP growth in the short run.

As far as taxes are concerned, the negative public reaction to the single percentage point hike in VAT in the 2018 budget suggests the political fallout from another hike would be big. And the paltry response of personal income tax receipts to the tax hikes of the past few years suggests that further income tax increases could now prove counterproductive, serving only to drive high-income earners to the golf course or the airport.

Hiking the corporate income tax rate, which is already high by global standards, any further would likely work against the government’s drive to boost business investment. Positively, however, we believe the new leadership and institutional rehabilitation at Sars will help boost the efficiency (and hence the quantum) of tax collections, but this will take time.

Thus, the government may finally be facing up to the need for big spending cuts. In June, the Treasury issued guidelines to national departments and provinces, calling for unprecedented spending cuts of 5% in the financial year 2020/2021 (relative to the existing budget baseline), and 6% and 7% respectively in the subsequent two years. However, the government’s promise at the jobs summit in 2018 to avoid mandatory retrenchments in the public sector would seem to hobble its ability to further curtail spending, especially since some big expenditure items, such as debt service and social grants, also cannot be cut.

Public sector payroll

In SA the public sector payroll now consumes 14% of GDP, more than nearly all other countries. Unfortunately, recent data from Stats SA show that employment levels in national and provincial government have actually grown over the past 12 months to the end of the second quarter of 2019, suggesting no progress so far with the government’s plans to use early retirement and natural attrition to downsize public sector payrolls. Thus the degree to which Mboweni is able to secure big spending cuts from various parts of government is the most important question mark hanging over the medium-term budget policy statement.

Of course, the government could also look to restructure its balance sheet by selling assets, which are earning a negligible rate of return, and using those receipts to avoid incurring further debts, on which it now pays about 8.5% interest. However, until now the governing ANC has appeared wedded to the idea of retaining its state-owned companies as a part of its developmental toolbox, despite their persistently poor performance.

Ideological opposition to privatisation within parts of the ANC and its allies in organised labour remains intense. The Treasury’s growth proposals published at the end of August argued that the state should stop subsidising loss-making and inefficient state-owned companies, and should sell those for which there is no developmental rationale, including Eskom’s coal-fired generating plants. However, the recent statement from the ANC’s national executive committee suggests no acceptance of this idea.  

Yet the scale of SA’s fiscal challenges, both within the budget itself and at loss-making state-owned companies, argues for bold measures now. Such measures might entail some short-term pain, but any serious efforts to stabilise SA’s public finances would also almost certainly lift business confidence, and hence private investment spending, and thus ultimately growth. Sustainable growth is in fact the most palatable solution, not only to SA’s fiscal challenges but also to its broader socioeconomic ones.

Unfortunately for everyone, growth outcomes are a result of a complex interplay of many endowment, cyclical and policy factors. It is not possible to turn up growth by simply flicking one or two easy policy switches. Many of the structural reforms needed to lift SA’s growth rate — such as selective privatisation, labour market liberalisation and educational reforms — are politically challenging and outside the direct control of the Treasury.

However, in the near-term a medium-term budget policy statement that sets out a viable and convincing path for fiscal consolidation is a first necessary step towards fixing SA’s economy. We wait with bated breath to see what Mboweni and the Treasury bring to the table in these challenging times. Only one thing is sure: the necessary fiscal medicine will not taste good and could be altogether unpleasant.

• Worthington is senior economist at Absa Corporate and Investment Bank.