ARTHUR KAMP: Fiscal sustainability requires more than a good medium-term budget
The trajectory is clearly unsustainable, and SA is at the point where it needs to change the underlying dynamic
In Wednesday’s medium-term budget policy statement (MTBPS), the National Treasury is likely to show the right intent and project stabilisation of the debt ratio over the medium to long term. However, this will rely on sustained higher GDP growth and onerous expenditure restraint.
The problem is SA’s track record on GDP growth is dismal and the expenditure ceiling has not been a reliable guide to actual expenditure outcomes. The 2021 medium-term budget projected the main budget expenditure ceiling at R1.559-trillion in 2023/24, but by the time the 2023 Budget Review was published this had increased to R1.671-trillion. The additional spending of R112bn amounts to 1.6% of estimated GDP.
The question is why, despite years of attempted consolidation, SA’s fiscal policy remains on a slippery slope. In part this reflects events beyond the Treasury’s control. Aside from the temporary impact of Covid-19, more enduring problems include tepid real GDP growth and the deterioration in the financial health of state-owned enterprises (SOEs). Eskom remains reliant on the central government to continue operating, while other SOEs seem likely to require additional support.
SA’s potential real GDP growth rate is at its lowest level since the late 1980s. Due to a high tax burden, there is limited scope to increase taxes without damaging already fragile economic activity. This situation is worsened by the recent fall in commodity export prices, which is expected to weigh on income growth, corporate profits and tax buoyancy.
Overall, a revenue shortfall of R60bn (0.8% of GDP) is expected in 2023/24. Combined with some expenditure slippage, this implies a main budget deficit of 5% of GDP in 2023/24, which is markedly larger than the deficit of 3.9% of GDP originally projected in the February 2023 Budget Review. This excludes support for Eskom amounting to R78bn (1.1% of GDP) in the current fiscal year. Though this is not reflected in the budget deficit, it must be funded and therefore increases government debt.
Unfavourable dynamics
It will be difficult to reduce the budget deficit meaningfully over the medium term. At about 32% of GDP in 2023/24, the government’s consolidated expenditure is too high. However, the 2023 Budget Review shows increases in consolidated non-interest spending of just 5% and 4.2% in current prices in 2024/25 and 2025/26, respectively, (before potential adjustments in the 2023 medium-term budget), which implies flat or possibly negative growth in real terms. Additional expenditure cuts will therefore be hard to implement.
It is untenable to ignore the plight of SA’s poor. Other than likely further support for SOEs, potential additional spending relates to a basic income grant (or extension of the social relief of distress grant) and National Health Insurance.
Unfavourable debt dynamics continue to churn in the background. The effective real interest rate on newly issued government debt is high relative to real GDP growth. We are unlikely to run a primary budget surplus large enough to stabilise the debt ratio. At best, the primary budget (revenue less non-interest spending) might be in balance over the medium term. Accordingly, the government debt ratio is expected to continue grinding higher over the medium term, to 76% of GDP or higher by 2025/26.
None of this will be news to market participants. Also, despite the unfavourable long-term dynamics a change to SA’s sovereign debt rating is unlikely. It is also helpful that we have deep, liquid capital markets, and the maturity structure of government debt is long. In addition, most of this debt is denominated in local currency, which implies less risk of a balance of payments crisis due to a shortage of foreign exchange to repay debt.
However, this can only carry us so far. The current fiscal path is clearly unsustainable. Though SA’s debt ratio may not look high globally, our debt has been increasing faster than that of most economies in our peer group, while the high real interest rate we pay on our debt in a slow growth environment implies that the government’s interest bill is absorbing an increasing share of revenue. Debt service costs have increased from 8.8% of main budget revenue in 2008/09 to about 20% in 2023/24, leaving fewer resources available for service delivery.
We are at the point where we need to change the underlying fiscal dynamic. Additional expenditure restraint (usually a necessity for successful fiscal consolidation) will be difficult to implement. This underlines the importance of lifting potential GDP growth and working towards sovereign debt rating upgrades to lower the effective real interest paid on debt.
Failing this, SA can be expected to continue drifting towards an unwanted fiscal endgame.
• Kamp is chief economist at Sanlam Investments.