Temporary windfalls no reason for a free lunch from expenditure thrift
Studies show fiscal consolidations that focus on expenditure cuts as opposed to tax hikes tend to have a less detrimental effect on the economy
Despite the setback to the SA economic recovery because of the Covid-19 second wave and load-shedding, a few unexpected — albeit possibly temporary, positive developments would have made the National Treasury’s February budget preparations somewhat less tense.
First, the boom in SA’s export commodity prices, along with the better-than-expected initial GDP recovery, have provided an unexpected tax revenue windfall. As an example, royalties and tax payments by platinum group metals (PGMs) and gold miner Sibanye-Stillwater surged more than 200% to R7.1bn in 2020. Overall government tax revenue should still decline by a worrying 10%-11% in 2020/2021, but this will beat the dire estimate at the time of the October 2020 budget statement by up to R100bn (2% of GDP). Linked to the positive commodity story is a sharp upgrade to global growth prospects thanks to the vaccine rollout and the looming huge (additional) US fiscal stimulus package. This should support the current account and a domestic export volume recovery in 2021.
Second, the government-friendly verdict by the labour appeal court in December 2020 means the Treasury can proceed with reneging on the 2020 salary adjustment that was part of the 2018 public sector wage agreement. The estimated saving of R37bn was part of the fiscal framework in October, but it was unclear whether this would still be possible now. As the dispute heads to the Constitutional Court, the Treasury can retain the October baseline on the wage bill. This in effect ties the medium-term framework to a nominal public sector wage freeze.
Third, lower SA bond yields and a roughly 10% gain in the value of the rand vs the US dollar has marginally pushed down the cost of government borrowing since late October. At the 10-year horizon the saving is about 40 basis points. Based on previous Treasury calculations, the bond market and currency moves could reduce debt service payments by about R4bn. Considering that in 2019/2020 interest payments had amounted to R205bn, or 13.5% of consolidated government revenue, this may sound immaterial. It is still a small positive, but could be short-lived should SA yields continue to rise amid the global reflation trade.
Despite these favourable developments a very large main budget deficit of 11.5% to 13% of GDP is expected for 2020/2021. This would push overall gross government debt towards 80% of GDP, with a further notable medium-term increase almost inevitable. Even excluding fast-rising interest payments, government expenditure is projected to handsomely exceed revenue until at least 2023/2024.
The sizeable 2020/2021 revenue overrun does suggest that the procurement of vaccines and the three-month extension of the R350 a month Covid-19 grant can be absorbed without more tax hikes on top of the R5bn already pencilled in for 2021/2022 and/or further expenditure reprioritisation. Still, against a backdrop is highly uncertain future nominal GDP growth and associated tax revenue, these additional expenditure outlays of roughly R20bn (say R15bn for vaccines and R6bn for the grant extension) highlight SA’s limited fiscal space. Possible further grant extensions and support for state-owned enterprises would add to the pressure, while the funding of the vaccine rollout is unclear.
There remains little room for fiscal complacency or slippage on the (adjusted) aggressive expenditure-based fiscal consolidation plan outlined in October. Given our pre-Covid-19 lost decade of declining per capita GDP and the accompanying huge socioeconomic challenges, we need to consolidate and at the same time protect growth.
An often-heard critique of fiscal consolidation programmes is that they are detrimental to GDP growth, hurt government revenue and end up further worsening the public debt dynamics. A standout finding from the academic literature is that this critique misses an important nuance. Many studies, including by the late Harvard political economist Alberto Alesina, show that fiscal consolidations that largely focus on expenditure cuts as opposed to tax increases tend to have a less detrimental effect on the broader economy.
While much of the research focus is on advanced countries, it also has significance for emerging economies, including SA. This is even more relevant after recent SA Reserve Bank research showed that, after falling in recent years, the government spending multiplier is low in SA. This implies contained growth costs of fiscal consolidation in SA.
The literature suggests that while successful episodes of fiscal consolidation tend to blend expenditure and revenue interventions, expenditure-based consolidations have proven to be better in reducing fiscal deficits. There are two main reasons for this. The first is that, as in SA, too much spending relative to government revenue often drives fiscal imbalances. Curtailing expenditure tends to have a more permanent effect on reducing fiscal deficits.
A tax-based consolidation plan that fails to deal with the automatic growth in entitlements and other government programmes would raise expectations of additional tax increases in future, hurting private sector fixed investment. By contrast, an expenditure-based (EB) plan that tackles structural (over)spending may lead to expectations of lower future taxes. This has been shown to support consumer and business confidence, as well as spending by households and firms. Therefore, EB consolidation programmes typically have a less damaging effect on GDP growth.
Judged against this, and in sharp contrast to some critics, the Treasury’s expenditure-based consolidation drive is evidence-based. Indeed, the strategy ticks several boxes, including the commitment to improve the composition and quality of spending. It acknowledges the imperative to save on current expenditure and spend more on infrastructure. There are many challenges in the infrastructure space, but the intent is sound.
Yet it is not uncommon for SA policymakers to have reasonable plans. The elusive trick has been no-nonsense implementation, inclusive of growth-enhancing structural reforms to complement the fiscal consolidation. Some of the groundwork for fiscal consolidation has been laid. This week’s budget needs to entrench this and (largely) stick to October’s fiscal targets.
The uncertain recovery prospects, including downside Covid-19 risks, may have prompted thoughts of an easing of expenditure frugality. There is, however, a delicate balance. SA bondholders, firms looking to invest and the ratings agencies are likely to baulk at a let-up on (current) spending cutbacks.
• Hugo Pienaar is chief economist at the Bureau for Economic Research, Stellenbosch University.
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