A brief time-out

In some ways the state of the world economy is less hostile today than when (then) finance minister Tito Mboweni read his Budget Speech a year ago. Global economic growth rebounded significantly in 2021 after the decimation brought about by the Covid-19 induced recession in 2020. One of the outcomes of this was a sharp recovery in commodity prices, which has resulted in much higher-than-expected mining tax revenue in South Africa. This, in turn, has provided some welcome – albeit limited – breathing space on the fiscal front. The local economy is thought to have grown by more than 4.5% in 2021 – the highest annual increase in more than a decade. On balance, the finance minister should be able to meet spending demands (including the extension of the SASSA payments) for the year ahead without widening the budget deficit, or resorting to punitive upward adjustments to tax rates. In fact, changes in the corporate and value-added tax rates seem unlikely, while a modicum of personal income tax relief is possible via an adjustment of the respective tax brackets.  As always, expect sin taxes to rise, although, in the light of the rapidly rising petrol price, the fuel tax increase will hopefully be more constrained.

 

But let’s not get carried away

However, it would be premature and foolhardy to interpret the 2021 growth performance, and the moderate fiscal easing, as a preamble to better times. First, arithmetic is a major explanation for the seemingly impressive 2021 global growth performance, as increases in output bounced back from the much lower base recorded in 2020. Already, growth forecasts for this year and next suggest a slowing in the rate of expansion. Locally, a resumption of a low growth trajectory (2% or lower) is projected for 2022 and 2023. Indeed, the SA economy might only recover to its pre-pandemic GDP per capita – and that was when the economy was already in the earlier stages of a recession – by the end of 2024.

Evidence is also emerging of a two-speed global recovery, partly based on the dichotomy between countries with comprehensive and effective vaccination campaigns (the “jabbed”) and those without (the “jabbed-nots”). It is also unfortunate that pent-up demand (following enforced spending restraint in 2020) is being stymied by supply chain disruptions across the globe. Compounding the fragility of the recovery is the expectation that the aggressive fiscal and monetary stimulus packages, introduced to counter the effects of the 2020 recession, have run their course. For the first time in over a decade inflation rates in some of the major developed economies have burst through the 2% level to reach 6-8%. The UK and the USA, amongst others, have already heralded a tightening of monetary policy as interest rates are set to rise from historically low levels.

Here at home, economic, financial, and fiscal conditions remain stressed.  The growth recovery is tepid and way below the pathway required to make meaningful inroads into the triple challenge of poverty, inequality and unemployment. The latter, which has been chronically high for the best part of two decades, has reached a record high rate of 35% (excluding discouraged work-seekers). Periodic and intrusive power shortages weigh heavily on the production capacity of all sectors of the formal and informal economy. Moreover, as is the case internationally, inflationary pressures are mounting, prompting two recent increases in the policy interest rate, with more on the cards.

 

A surplus of deficits

Fundamentally, the country’s economy is staggering under the weight of a variety of deficits.  Not all deficits (and debt) are, pernicious. For instance, when used for the right reasons (such as financing economic infrastructure) government (public) debt can improve the standard of living and development in a country. By building new roads, railway lines, bridges, and dams, and by improving education and providing pensions, the future potential output of the economy is enhanced. Similarly, if households incur debt to acquire housing stock or transport goods, they are earning a long-term yield in the form of accommodation and transport. In addition to this, the paradox of thrift (savings) tells us that an increase in total saving leads to a decrease in total demand, and a corresponding slowdown in production. Thus, while individual saving is deemed to be a virtue, collective saving (by all households) may be harmful to the economy. In fact, in the event of the latter, debt countervails saving by recycling unspent funds into the circular flow of income.

However, repeated and widening deficits can indeed be harmful. Governments, for instance, may be tempted to assume more and more debt because in the short term it may make them popular with voters – especially as it means that they do not have to raise tax. This kind of thinking is flawed on a number of levels. If the level of debt consistently rises at a faster rate than the GDP, the ratio of public debt-to-GDP could reach a critical level where investors in government bonds (creditors) will demand a higher interest rate to compensate for higher risk. As interest rates rise, it becomes more expensive to refinance existing debt and to finance new debt. Moreover, since more government revenue has to be allocated to the servicing of debt, less is available for crucial government services. If, in addition, government debt is incurred to finance mainly current expenditure (and, at critical levels, debt servicing costs), the burden of the debt is exacerbated since it is not making any meaningful contribution to the future production capacity of the economy. In an extreme situation, a sovereign debt crisis may arise, with the risk of a lower credit risk rating.

The same basic concerns apply to household debt. The higher the ratio of household debt to disposable household income, the greater the risk of default – especially if the debt is used to acquire non-durable goods and services.

South Africa has, for some two decades, been running fairly significant – and often widening – savings, government and current account deficits. Conventionally, a current account deficit will be financed through net financial inflows. By implication, therefore, a country’s savings and government deficit needs to be financed through net financial inflows. To add to the challenge, there is general consensus that South Africa requires a sustainable and inclusive economic growth path of 6% to reach the country’s unemployment and poverty goals. One of the prerequisites for this is a GCF-to-GDP (i.e., fixed investment as a share of GDP) ratio of approximately 30%. Currently, the latter is languishing at barely 17%, with the savings rate much lower at 15% of GDP. To elevate the investment rate by more than 10 percentage points, one or more of the following has to occur:

• A substantial decline in consumption expenditure by government. This is problematic. For instance, while a reduction of the civil servant wage bill and/or expenditure on social grants is economically and financially justifiable, it is politically and even morally more difficult to defend.
• An increase in the tax burden. Whilst this may make sense from an arithmetic point of view, the negative multiplier effect on the economy, given an already overburdened tax-paying nation, could be self-defeating.
• A profound swing on the current account of the balance of payments. A current account surplus may be recorded sporadically on the back of transient surges in commodity prices (such as in 2021). However, we cannot rely on windfalls – current account deficits are more likely to persist, given the struc­tural obstacles to South Africa’s competitiveness, such as high labour costs and infrastruc­ture/logistical constraints.
• A significant decline in the share of household consumption spending. This is an imperative, but clearly an unpalatable one, since it implies a short-term sacrifice for the sake of longer term dividends.

That leaves movements on the financial account. Financial account flows are essentially a function of the relative attractiveness to foreign investors of a country’s investment climate. To paraphrase an old adage: ‘Capital moves to those places where it is well-rewarded and well-treated’. Thus, if – as was the case until 2010 – interest rates are significantly higher than in the advanced economies, while economic growth appears to be robust, investment will flow into South Africa, especially when the political situation is seen to be stable and the macro-economic fundamentals are sound. The concomitant inflow of foreign currency results in a stronger domestic currency.

If, however, there is a sense of incremental instability, while the interest rate gap is narrowing, risk-averse investors will tend to take flight, thereby reducing the supply of foreign currency and/or raising the demand – hence, a weaker exchange rate. The reality is that a considerable proportion of South Africa’s financial account is comprised of portfolio and other flows, which are particularly susceptible to the vicissitudes and vagaries of foreign investors’ decisions, based, at times, on perceptions and whims. That said, there is a fundamental, structural truth for SA (Pty) Ltd: As long as the country spends more than it produces and earns, it will continue to rely on foreign savings to bridge the gap. And that is what ultimately makes the exchange rate vulnerable to changes in investors’ views and actions.

A concern regarding the nature of growth in South Africa over the last 25 years is the fact that it has been largely underpinned by consumption expenditure (both private and public). Moreover, the growth in private consumption expenditure has been largely financed by credit. This is reflected in the increase in the ratio of household debt to disposable income from 55% in 2001 to almost 90% by 2009, and a still high 75-80% today. The implication is that South Africa’s economic growth path is debt-driven, and therefore not sustainable. In fact, as households attempt to ‘fix’ their balance sheets (through a deceleration in the demand for credit) economic growth will lose momentum.

 

Flirting with fiscal extravagance

This brings us back to the 2022 Budget Speech. The commodity price windfall and relative buoyancy of economic activity might provide a temporary fiscal respite. Structurally, however, South Africa is flirting with fiscal adversity. The decade-long accumulation of government debt has elevated the government debt- to- GDP ratio to unprecedented levels. There is now a very real risk that in the years ahead social grants, civil service wages, and debt servicing costs will absorb the bulk of government revenue (tax).   An immediate impact of this state of affairs is that government is simply not in a position to embark upon the expected policy approach to counteract recessionary conditions, viz. a programme of fiscal expansion. In the longer term, capital expenditure by government (especially on much-needed economic infrastructure) will be crowded out by far less productive current expenditure.

 

Thinking beyond the near term

We should not and cannot expect miracles; a budget speech is not meant to a blueprint for sustained economic recovery and transformation. When all is said and done, the budget speech is a three-year review of projected government expenditure and revenue. At the same time, the intended allocation of the revenue to various government programmes does give an indication of the government’s priority preferences and objectives.

This year’s budget speech might – more through luck than judgement – be relatively benign for consumers, taxpayers, citizens, and businesses. The problem is that sporadic, unpredictable strokes of fortune merely create an illusion of congeniality and mask the real challenges. Now, it is more important than ever before for this year’s budget to show a serious and plausible intent to curb the accumulation of debt. This requires a marked narrowing of the budget deficit by restraining the growth in government spending and/or raising tax revenue. The latter would be unfortunate in the light of the sluggish economic growth performance, the higher interest rate environment, and the vulnerability of the poor and the unemployed. With a view to the future, the budget speech will ideally mark a “rebooting” of government expenditure in favour of capital (as opposed to current) expenditure.

In his recent State of the Nation Address (SONA) President Ramaphosa laid down a few potentially game-changing markers for socio-economic advancement, including the following:

• Acknowledging that the private sector is the major contributor to growth, development, and investment; government should therefore create an enabling environment.
• Government should not be seen, nor act, as a major employer.
• Self-employment should be a major source of job creation.
• The intention to reduce red-tape, thereby making it easier to do business in the country.
• Initiatives aimed at security a reliable supply of electricity (including renewable energy sources).

Hopefully, the finance minister will endorse these sentiments and elaborate upon them. Plausible and do-able action speaks louder than words. If it means making difficult and uncomfortable trade-offs when balancing efficiency with equity, then so be it.