No silver lining to gloomy growth outlooks
After the supplementary budget questions remain on the state’s ability to deliver on a path of fiscal consolidation and debt stabilisation
Finance minister Tito Mboweni’s supplementary budget highlights the stark reality of the fiscal, economic and social crisis facing SA. As we all have come to realise in the past few months, the Covid-19 pandemic and lockdown measures put in place to contain its spread have collapsed SA’s already weak growth prospects, dumping us into the biggest economic contraction since the Great Depression.
The National Treasury now forecasts GDP to contract 7.2% in 2020, close to the SA Reserve Bank’s forecast. Meanwhile, the IMF, which also published its revised global growth forecasts on the same day the supplementary budget was presented, now expects the economy to contract by 8% this year, and Absa Research’s is even more gloomy, with our forecast that GDP will shrink nearly 10% this year as large parts of the economy, such as tourism, suffer a mortal blow and demand is impaired by rising joblessness, pay cuts and shattered confidence. And yet we are far from the most pessimistic in our forecast on growth.
Admittedly, uncertainty is high, but regardless of the exact outcome for GDP in 2020/2021 the macroeconomic context for SA’s budget performance this year is extremely unhelpful. Against this backdrop finance minister Tito Mboweni and the National Treasury had a difficult task. Their projected tax shortfall of R304bn (compared with the original February budget target) is huge.
And of course, the Covid-19 pandemic has necessitated huge increases in front-line health and economic support spending in 2020/2021. As the supplementary budget makes clear, spending to respond to Covid-19 has been increased to R142bn, while the Land Bank received a R3bn injection from the fiscus as well.
Most of this R145bn extra spending is financed by a far-reaching reallocation within the existing budgetary envelopes, but total non-interest spending is nonetheless still projected to be R36bn higher than envisaged in February. Consequently, the Treasury forecasts the main budget deficit to come in at 14.2% of GDP in 2020/2021 and the consolidated deficit at 15.8%. Stripping out interest payments from the main budget balance, the primary deficit is a whopping 9.7% of GDP.
Unfortunately, we believe the risk to the government’s deficit targets is tilted in the adverse direction. First, our gloomier growth outlook might now suggest an even bigger tax shortfall, taking Treasury’s tax elasticity as a given. Second, weaker GDP growth also means a smaller denominator in the deficit ratios. Third, we see ongoing possible upward pressure on spending this year.
For example, though Mboweni said the R50bn emergency increase in social grants would terminate as planned in October, we believe the economy will be in no shape at that point to generate many jobs and restore lost incomes. Therefore, it may be politically and socially impossible to roll back the expanded social grants. The R19.5bn provisional set aside offers some limited scope to extend them, though not for long.
For the same reason we also see some upside risks to spending from the Unemployment Insurance Fund (UIF) and temporary employee/employer relief scheme (Ters), which set aside R40bn from the surplus in the UIF for enhanced unemployment support, more than half of which has already been disbursed. The government may also be forced by unions’ court action to implement the third year of the pay deal, which is not included in the supplementary budget targets.
Overall, Absa Research sees the main budget deficit coming in at 16.2% of GDP this year. More important than the outcome for the current year, however, is the government’s plans. How will it respond to the huge fiscal imbalances and unsustainable debt trajectory? Mboweni said it would be a Herculean task and warned of an economic meltdown such as Zimbabwe’s or Argentina’s unless the government and the country embarked on active adjustment.
Interestingly, planned tax increases are modest at this stage: just R5bn in 2021/2022 and R10bn in 2022/2023, and again in 2023/2024. However, the supplementary budget warns these provisional targets could be revisited at the medium-term budget policy statement (MTBPS), while details on which tax levers would be pulled will only be announced in the 2021 budget next February. Still, such modest amounts suggest the government is not thinking about a VAT hike at this stage and understands that it cannot squeeze more out of personal income tax or corporate income tax when the economy is so weak.
Rather, the supplementary budget, along with Mboweni’s speech, points to a Herculean effort to slash spending. To this end the Treasury will introduce zero-based budgeting from the October MTBPS, under which all spending programmes must be justified with each iteration of the fiscal plan. However, it is unlikely that this measure alone can deliver the scale of expenditure cuts envisaged without greater flexibility in managing the public sector pay bill.
If various government spending programmes are cut under zero-based budgeting as no longer delivering value for increasingly scarce public money, what happens to the public employees supporting these programmes? The supplementary budget briefly notes that R230bn of expenditure cuts are needed in the next two fiscal years, on top of the R160bn of savings on public sector pay pencilled into the original February budget, but gives no details on how these can be achieved.
This detail will likely have to wait until at least the MTBPS in October, or possibly even into next year. For one thing, a pay deal with the public sector unions for 2021/2022 onwards, secured either via collective bargaining or imposed unilaterally by the government, is unlikely to be fixed by the time of the MTBPS. All told, however, a mighty battle with the public sector unions seems to be brewing and there are likely significant execution risks to the government’s plans for such big spending cuts.
Consequently, there are big risks to the government’s extremely ambitious deficit reduction path, as laid out in the supplementary budget. From a primary deficit this year of 9.7% of GDP the government aims for a tightening of more than five percentage points of GDP in 2021/2022, mainly through as yet unspecified spending cuts, against a backdrop of continuing tepid growth. And further tightening is planned for subsequent years, leading to a primary budget surplus and debt stabilisation by 2023/2024.
Fiscal adjustment averaging three points of GDP over three years would be breathtakingly fast. If the government can deliver this it will be a major achievement, but the execution risks are high; though a structural reform programme that lifts SA’s growth path would mitigate them materially. Notably, the supplementary budget is modest on its expectations for a growth recovery after the Covid-19 shock in 2020. Like Absa Research’s view, Treasury expects GDP growth of 1.5% per year from 2022 onwards.
A broader, deeper and faster programme of structural reforms, which includes previously untouchable topics as such as labour market liberalisation and overhauling the state to make it more efficient, would help a great deal over time, but ideological contestation remains a big hindrance at present. All in all there remain big questions about the government’s ability to deliver on a path of fiscal consolidation and debt stabilisation.
• Worthington is Absa senior economist.