No pain, no gain for SA economy
Some pain is unavoidable in stabilising the fiscus, but politically palatable options do exist that might just do enough to appease the ratings agencies and financial markets
Despite SA’s fiscal crisis — and the fact that the country has very little to show for the loose fiscal policy run over the past decade — there is a lobby (mainly on the Left) that thinks the best way to resolve SA’s growth and fiscal challenges is to inject further fiscal stimulus into the economy.
This view has been well and truly punctured by a new academic study. It finds that if the government fails to take evasive action and SA’s growth rate, interest rates and the primary budget balance all remain at their recent averages, the debt ratio will hit 100% by the end of the next decade.
However, if wage-bill growth is curtailed, state spending is cut, and state-owned enterprises (SOEs) are restructured in a partial one-off debt takeover event, it should be possible to stabilise the debt burden at 67% of GDP over the next three years. This might be enough to keep financial markets and ratings agencies onside.
This is the message contained in a new briefing paper by two leading academic economists, presented to the Reserve Bank and the National Treasury, on the most politically palatable way to prevent SA from sliding into a debt trap.
Prof Philippe Burger of the University of the Free State, who worked on the paper with Stellenbosch University emeritus professor Estian Calitz, is hoping to present the findings directly to President Cyril Ramaphosa at his next economics roundtable.
Burger and Calitz show that the root cause of SA’s debt explosion over the past decade has been an increase in government expenditure on all the wrong things.
Instead of investing mainly in infrastructure and productive assets that would increase SA’s long-term growth prospects, almost two-thirds (63%) of the hike in government expenditure over the past decade went on the wage bill, according to International Monetary Fund (IMF) estimates. A further 23% went on debt-servicing costs, while 15% went on social grants (see graph).
Burger and Calitz show that if SA continues this accommodative policy stance (running a primary deficit of 1.5% of GDP), the economy will need to grow at 6.8% just to stabilise the debt ratio — which is a very unlikely scenario.
If no attempt is made to rein in the primary deficit, real GDP growth remains at its long-term average of 1.5% and real interest rates remain at about 4%, then SA’s debt ratio will hit 100% by 2031.
The IMF’s senior resident representative in SA, Montfort Mlachila, addressed the same issue at a recent Bureau for Economic Research (BER) conference in Sandton, warning that there is limited fiscal space to provide an additional boost to growth.
He pointed out that fiscal policy in SA had been accommodative since the global financial crisis: budget deficits remained at about 4% of GDP, while debt levels more than doubled. But things have reached the point where debt-servicing costs are increasingly crowding out socially desirable spending, and the public debt trajectory is becoming "uncomfortable".
Burger and Calitz show what it would take to keep the debt ratio from worsening beyond the psychological threshold of 60% of GDP, which is roughly where it is expected to be at the end of 2019/2020, following the recent Eskom bailout.
"The message has to get home that we have run out of road down which to kick the can," says Burger in explaining why they drew the line at 60%. "In addition, in the academic debate, some argue that once you exceed 60% the debt ratio starts to [affect] the interest rate level."
They say the most politically palatable way to stabilise the debt ratio at 60%, assuming real GDP growth recovers to 2%, would be for the government to reach a deal with the unions to limit the growth in the nominal wage bill over the next three years to half of expected nominal GDP growth.
This would allow for the salary bill to rise in nominal terms, but job cuts would be required if workers demanded that their salaries keep pace with inflation.
If the government could curb the wage bill to this extent, it would carry half the required fiscal adjustment. The rest would have to be borne by cutting the government’s goods and services budget by about 1.5% of GDP (roughly R80bn) over the next three years.
This would allow for the goods and services budget to keep growing in nominal terms — but it is a big ask, given that the fiscal consolidation of the past five years has cut only about R70bn from spending.
Burger believes the government can save much by ending corrupt contracts. "In fact, the more corrupt contracts they cut back, the less pressure they will need to put on the salary bill," he says.
If, however, SA were to spare the goods and services budget, it would have to freeze the wage bill for the next three years and grow the economy at 6.5% to stabilise the debt ratio — neither of which is remotely feasible.
Capital spending should not be cut, because this would just reduce SA’s long-term growth prospects further, say Burger and Calitz. Neither should social grants be cut, because of the important role they play in alleviating poverty and inequality.
The message has to get home that we have run out of road down which to kick the canPhilippe Burger
And there is very limited room to raise taxes, as SA is already highly taxed for an emerging market. Indeed, SA’s total revenue-to-GDP ratio is higher than 20 other emerging markets and five developed economies: the US, Switzerland, South Korea, Australia and Israel.
In short, there are no new funds available, and no room to institute new taxes, such as a social security tax, to fund new policies like National Health Insurance. Instead, the government may well have to cut back existing programmes.
But dealing with the wage bill and current expenditure is only half the problem. The government must also wrest back control over its SOE portfolio.
The report suggests the government deploy the good bank/bad bank model that was used to good effect during the global financial crisis, especially in the US.
Using such a model, SOE assets and liabilities would be separated into new, "good" SOEs holding assets, with the old, "bad" SOEs holding debt. The government would sell equity stakes in good SOEs to private investors and recapitalise their remaining assets using government capital and new SOE loan debt. Some of the loan debt could be turned into equity once the new, good SOE started performing.
"The funds raised by selling off stakes in the new, good SOEs would in essence mean that they use these funds to buy out the assets from the old, bad SOEs, which, in turn, use the funds to extinguish the old, bad SOE debt," explain the authors.
But given that total SOE debt, including Eskom’s, is just over R1-trillion (about 22% of GDP), it is unlikely that more than half of this could be extinguished through selling equity stakes. If the government takes the remaining R500bn onto its own balance sheet, the gross debt-to-GDP ratio would increase from 57% to 67%.
"This might be acceptable to financial markets and ratings agencies if they understood it as part of a restructuring package that limits the impact on the fiscus to that of a one-off debt takeover event," the authors say.
However, they stress that this exercise will have to be matched by the restructuring of SOEs’ operational models to return them to profitability.
In cases such as Eskom, this means that cost-cutting, including retrenchments, will be unavoidable.
The government is committed to ensuring fiscal sustainability, says Busani Ngcaweni, the head of policy & research services in the presidency.
Speaking at the BER conference, he said this would be achieved by stabilising the debt ratio in 2024/2025 by running a sufficiently large primary budget surplus. In addition, the government would reduce the public sector wage bill and current transfers while protecting spending on infrastructure.
It would also "cut frills and fat, and review unviable programmes and agencies" while taking concrete steps to reduce the state’s contingent liabilities by fixing SOEs, he said.
The first evidence of this approach is in the technical guidelines recently issued by the Treasury to all government departments. Though the final directive is still subject to political sign-off, departments must prepare plans to cut their budgets by 5%, 6% and 7% over the next three years.
Departments have also been told that no additional resources will be forthcoming, so if more funding is needed for a programme, the equivalent cuts must be made elsewhere.
So, it seems that the presidency and the Treasury have embraced the best fiscal advice and are not falling for populist tax-and-spend solutions.
Now, if the government can just properly embrace the private sector in the financing, construction and management of public infrastructure and some services, such as power generation, the economy might be able to recover along with the fiscus.