Should we blow the budget to prop up growth?
The risk of a policy error is high as SA contemplates a fiscal stimulus package to reignite growth, but without stepping over important boundaries
Well before the recession became official, economists started debating what SA’s correct fiscal stance should be, given falling growth and rising unemployment. Should we blow the budget to prop up growth?
It’s a difficult question to answer when there are multiple pressures on the national budget but very little fiscal wiggle room, the ratings agencies are circling again and the global environment has become hostile.
Against this backdrop, finance minister Nhlanhla Nene is expected to pull a rabbit out of the hat with the October mini-budget.
After its midyear lekgotla, the ANC said it wanted to introduce a fiscal stimulus of R43bn. It suggested tax credits for companies that create new jobs; greater fixed investment into roads and bridges, water and sewerage projects, housing and public transport; better support for emerging farmers; and an expansion of the public works programme.
The National Treasury countered that R43bn could be found only through reprioritisation. There was no new money. But that was before the economy entered a recession.
Now that it has, the political pressure on the government to do something is becoming intense. The concern is that the Treasury could be instructed to accommodate an unaffordable fiscal stimulus package made up mostly of government spending — something that is unlikely to change SA’s growth trajectory.
If so, SA will have added to the mountain it has to climb to achieve long-term fiscal sustainability — and for little short-term gain.
Nene did his best to allay these fears last week. At a Moody’s summit in Johannesburg, he said the foundation for faster growth lies not only in making the requisite investments but also in strengthening governance, narrowing the budget deficit and stabilising debt.
The cabinet has agreed, in endorsing the medium-term budget policy statement to be presented on October 24, that "fiscal sustainability must remain the focus of government’s efforts in public finance management", he said.
So while the fiscal stimulus package has yet to be announced, according to Nene (and subsequently confirmed by Ramaphosa) it will be deficit neutral (not funded through additional borrowing) and focused on unlocking efficiencies in the public sector.
"At a time when global interest rates are rising, all public sector institutions need to be more prudent in their borrowing and ensure that these funds are matched to projects with high returns and [a] high development impact," Nene said.
Even so, there are two reasons to be sceptical of the ability of a fiscal stimulus package to translate into faster growth.
The first is that the state’s spending efficiency is extremely low. There is such a tenuous link between higher government consumption spending (such as on agricultural support) and improved outcomes (bigger harvests) that any stimulus package relying on it is tantamount to throwing money at the economy in the hope that some will stick.
Second, proposals to boost government consumption spending only make sense if the country has a cyclical deficient-demand problem (a temporary reluctance to consume). Rather, the real problem seems to be entrenched supply-side constraints that impede investment and output.
In designing a fiscal response to the recession, the government needs to understand this distinction. It first needs to identify the source of the economy’s inability to grow.
If it is the weak productivity of private enterprises — as a result of rampant input cost increases, skills shortages, red tape and regulatory uncertainty — then the answer to getting growth going doesn’t even lie in the realm of fiscal policy. SA may be better off easing immigration controls than building a new bridge.
Given how fiscally constrained SA is, this would be good news provided the government is able to move on the policy front, but President Cyril Ramaphosa ostensibly lacks the political capital to do so.
"Pure Keynesian-style aggregate demand stimulus may make us feel happier for a short while, but the hangover will last forever and the poor and middle class will inevitably carry a very difficult share of the burden," says Matthew Simmonds, a public finance consultant and former deputy director-general of the budget office at the Treasury.
"A well-thought-out programme of government spending aimed at supporting economic growth and inclusion, as well as a plan for its financing, could be important. It is, however, unlikely to address the more important structural barriers to profitability in the private sector, and affordable living costs for poor and middle-income households."
The real challenge, he feels, "is to package something that addresses the underlying economic needs of the country, rather than a patchwork of political concerns and vested interests". It also needs to be something that can be implemented soon and withdrawn as the economy begins to accelerate.
This is much harder than many people realise, he says, given that there are few people willing to champion the kinds of reforms from which SA would really benefit.
As such, ramping up infrastructure investment remains the government’s default strategy. According to Nene, it is redoubling efforts to address the infrastructure backlog. So far it has subjected 38 projects to rigorous financial and technical evaluation.
It will be relying on development finance institutions as well as commercial banks and other financiers and private sector companies to leverage concessional finance and the project implementation capacity to deliver these projects faster and more efficiently, he says.
But Sanlam Investment Management economist Arthur Kamp points out that accelerating public sector capex will require a big improvement in the efficiency of the entities and departments spending the money.
Unless the private sector can be convinced that these improvements are real, it will be reluctant to invest in these projects. This will keep the related borrowing costs prohibitively high. That is, unless the rumours are true that China is coming to the party with R370bn in concessional finance.
Other measures under consideration include curbing fuel price hikes to reduce pressure on household and business income, and giving job-creating businesses tax credits.
"But subsidies, once implemented, are difficult to remove," says Kamp. "Tax credits to companies are easier to withdraw at a later time, but that would defeat the objective. Tax cuts or credits must be viewed as permanent otherwise their effectiveness is reduced."
These measures will not address the fundamental problem: SA’s low potential growth rate, which leaves it vulnerable to external shocks like the current emerging-markets rout. SA, with its twin fiscal and current-account deficits, has been one of the hardest hit.
"We cannot ignore the global backdrop," says Kamp. "Now hardly seems the time to loosen fiscal policy further from an already vulnerable position."
what it means:
Capex is the easy part — but SA can't delay structural reforms if it wants to grow faster
During the current sell-off, the rand has depreciated by more than 11%, putting upward pressure on inflation and complicating the conduct of monetary policy, with which SA’s fiscal stance is intertwined.
The Reserve Bank’s job is to stick to its inflation target, but its ability to do so partly depends on sensible fiscal conduct by the rest of the government. Given that the Bank is under pressure to hike rates in response to the steep depreciation in the rand, it would be self-defeating if the government loosened fiscal policy now, only for this to tip the Bank over into a hiking cycle.
An additional consideration is how the ratings agencies would respond to SA taking on more debt and breaching its fiscal consolidation targets to mount a fiscal stimulus at this time.
SA’s foreign-currency debt is junk-rated by Fitch and S&P Global Ratings and on the lowest rung of investment grade with Moody’s. Should Moody’s capitulate, SA government bonds would be evicted from the world government bond index, which would trigger rand weakness and higher inflation.
Fortunately, Moody’s has indicated that it will not junk SA at its October review. In fact, despite forecasting some fiscal slippage in the 2018/2019 fiscal year, it believes that growth will pick up slowly and that SA’s fiscal consolidation plan is still achievable over the medium term.
So SA can count on some breathing room from Moody’s. However, the country should be actively pursuing sovereign rating upgrades to reduce pressure on interest rates, not just trying to avoid further downgrades.
"In the end, whatever fiscal plan we come up with, its likely success will depend on whether it cuts government consumption, boosts capital expenditure, aligns the tax structure with the economic growth objective, and protects the state’s balance sheet," says Kamp.
The onus is, therefore, on the government to develop the kind of package that investors will be willing to lend money to, adds Simmonds. But it must also demonstrate a real willingness to undertake the more important structural reforms to reduce the cost of business and living.