Newsletter 45 – Gordhan’s gamble - 30th October 2009
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While the Medium Term Budget Policy Statement has been well received by the financial and business press it does harbour a risk of South Africa confronting a debt-trap scenario at some point in the next decade. Considering the risks and the difficulty of predicting the country’s future GDP growth trajectory, history might find that the government erred in its fiscal response to the economic downturn.
The minister of finance, Mr Pravin Gordhan, delivered his speech to Parliament on Tuesday. It was generally well received. In emphasising the importance of inflation targeting, easing foreign exchange controls, and playing down the introduction of a national health insurance scheme, Mr Gordhan suggested that his ministry would not be dictated to by the Congress of South African Trade Unions (Cosatu) and the South African Communist Party (SACP). The head of Cosatu, Mr Zwelinzima Vavi’s, angry response to the minister’s speech, made to the SABC, further suggests that the minister got something right.
But in terms of growing Government indebtedness there is reason to be concerned. Mr Gordhan confirmed what many economists had already forecast: that government revenue for 2009/10 would be approximately 10% or R70 billion below budget. The shortfall is composed chiefly of company income tax expected to be R21 billion below its February forecast, VAT receipts are expected to be R31 billion lower than forecast, and customs revenue is expected to be R9 billion short of its forecast due to declining imports.
Expenditure, on the other hand was expected to increase by approximately R127 billion from the year before. As a result the budget deficit is now expected to reach R184 billion or 7.6% of GDP. In order to finance the deficit and also the financing requirements of Eskom and some municipalities, the total public sector borrowing requirement for 2009/10 was expected to reach R285 billion. This is a significant increase on the figure of R89 billion from the year before.
Mr Gordhan pointed out that a number of countries faced with similar revenue shortfalls had cut expenditure. South Africa would however seek to maintain levels of expenditure through borrowing. The level of such borrowing amounted to South Africa’s ‘fiscal response to the downturn [being] one of the largest [in the world]’.
Critical to the minister’s statement was that South Africa resume a GDP growth rate of over 3% by 2012. He forecast that negative 1.9% GDP growth for this year would be followed by positive 1.5% growth for 2010, 2.7% growth for 2011, and then 3.2% growth by 2012. The minister did admit that there was ‘considerable uncertainty in these numbers’.
The R285 billion public sector borrowing requirement is equal to 11.8% of GDP. The minister pointed out that this would see government debt increase from 23% of GDP in March of this year to 41% by March of 2013. The Government’s interest bill will as a result double from the R54 billion last year to R100 billion by 2012/2013.
The minister’s growth forecasts allowed him to forecast a recovery in government revenue from the estimated R589 billion for this year to an approximate R800 billion by 2012/13.
It is important to realise that if the minister’s growth forecasts do not materialise then the Government’s debt servicing bill as a proportion of GDP will increase proportionately. It is also important to realise that the minister’s fiscal response to the economic downturn is one that cannot easily be repeated. The Government would be risking a classic debt-trap scenario if it found itself in a position three years from now where growth has not materialised and it was again forced to borrow to sustain levels of current expenditure.
It must also be kept in mind that the average 4% GDP growth rate that the country sustained between 2000 and 2008 coincided with the tail of a global commodity boom. Also in the very early period of that growth, the rand/dollar exchange rate averaged roughly R9 to US$1. The rand did however strengthen appreciably through 2004/2005/2006. More importantly the higher growth rates and lower interest rates of the mid 2000s coincided with a rapidly increasing current account deficit, a steep fall in personal savings levels, and a significant increase in levels of household debt. These levels increased from roughly 50% of household incomes in the early 2000s to close on 80% by the late 2000s.
This pattern suggests that the 4% average growth rate of the 2000-2008 period was driven largely by consumer spending funded by borrowing on lower interest rates to buy things that were imported. Such growth was not sustainable and a repeat of a pattern that sees growth correspond to rising levels of household debt AND a high or increasing current account deficit will not be sustainable either. The minister’s GDP growth forecast of 3.2% by 2012 should therefore not be regarded as a sure thing.
If his growth forecast does not materialise then South Africa will find itself in considerable trouble. It would not advisedly be in a position to borrow further to fund current expenditure. At the same time the Government has incurred a substantial political liability in funding the incomes of poor households through social grants. It has incurred a further political liability in funding the lifestyles of its ‘deployees’ through the deployment policy at work in the public sector. Also in the public sector the Government has become beholden to the unrealistic wage demands and increases demanded by the public sector labour unions. Politically the ANC would be reluctant to cut expenditure in any of these areas as that would risk the patronage with which it maintains its political hegemony in South Africa.
It is also unlikely that the labour market will come to the rescue of the government in providing more households with an income. South Africa’s poor public education system will mean that its relatively strict labour market entry regulations continue to keep young black people out of jobs. Lower than forecast economic growth will merely exacerbate this problem. The government does realise this and is therefore using the expanded public works program to circumvent its own labour laws.
The Government will therefore have to consider higher taxation both to service the debt it is now incurring and to maintain the degree of expenditure to which it has become accustomed. This will of course further dampen growth and thereby over time erode or retard the growth of the tax base.
The minister has therefore taken a considerable risk in running up the budget deficit in order to sustain government expenditure. Numerous current revelations of how public sector managers loot the public purse cast doubt on how effectively the borrowed funds will be employed. It may have been more prudent to cut expenditure in line with many other economies.
Where could the government have cut 10% of its expenditure the critics will ask? Well in exactly the same places that the private sector cuts expenditure to balance its books. This would include a retrenchment of public sector staff starting with less than productive employees of which there are many. Other employees could be required to take pay cuts in order to save jobs. The incurring of new current expenditure such as the extension of social grants should have been suspended. Wasteful current expenditure such as exorbitant hotel bills, cars, houses, and entertainment, of which the media uncovers a fraction, could have been halted. The recovery of money stolen by officials could have been conducted with more zeal. Loss making divisions of government such as many of the public enterprises could have their bailouts cut and then be auctioned off. The SABC would have been a good place to start. The funding of the largely useless Chapter Nine organizations could be cut. The financing of new cabinet portfolios should have been frozen. If that could not add up to 10% then the government would have to reconsider some of its capital commitments such as the building of the Gautrain and the purchase of new aircraft for the defence force.
The point is that in three, or six, or nine years time the government may in any case be forced to do much of this although from the position of having become a heavily indebted nation. Having done it now would have mitigated many of the risks of South Africa finding itself confronting a debt-trap in the future.
- Frans Cronje
by
nkgafela
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last modified
2009-11-06 11:16
