Johannesburg - The South African government's latest wage offer to striking public sector workers will lead to increased state borrowing and may put the country's sovereign credit rating under threat.
The lessons learned from Europe's debt crisis are still fresh in the minds of South African authorities and they want to press on with plans to slow down borrowing and cut the country's large budget deficit.
But the government's improved offer of a 7.5% wage increase - double the inflation rate of 3.7% - and an R800 housing allowance puts a damper on those plans.
The state's wage bill already makes up a third of its entire spending and almost half of the tax revenue it collects.
"Put simply, government will be borrowing money to pay wages and debt service costs. This is not only unsustainable but will require future generations to pay for our current spending," said government's spokesperson Themba Maseko in a statement on Sunday.
"The fiscal trajectory over the next few years aims to moderate our borrowing while continuing to support the economy ... Unexpected growth in wages will compromise our ability to meet those objectives," he added.
After two years of surplus, the budget deficit widened to 6.7% of GDP in 2009/10, with plans to trim it to around 4% by 2013 and moderate borrowing.
"Anyway you (look at it), it's exceptionally difficult for government to give in to the high wage demands in this environment," said Dennis Dykes, chief economist at Nedbank.
"It will mean they have to cut expenditure elsewhere ... They can cut on fixed investment spending and then you would have a situation where the economy doesn't grow." he said.
Rating's concern
Investors have praised South Africa's prudent fiscal policies of the past decade, which have helped to gradually improve the country's credit ratings from international agencies.
At 28%, South Africa's debt to GDP ratio still pales in comparison to the much higher levels of some countries in Europe and government has projected it will reach 40% in 2013.
International ratings agencies have warned of risks to the country's ratings on any hint of expanded fiscal spending.
"We already have a negative outlook on the (South Africa) rating and for some time we've been flagging some downside risks with regards to rating," said Konrad Reuss, managing director for South Africa and sub-Saharan Africa at Standard & Poor's.
"We've seen high wage settlements for a number of years, which might be followed by another one now. Already in February the finance minister (Pravin Gordhan) highlighted there's very little flexibility to accommodate this."
"In the broader context of budget commitments and fiscal flexibility this is a concern," Reuss said, adding S&P will wait for October 27's medium-term budget policy statement to make a call on ratings.
Moody's also said in March any relaxation of spending policies could threaten ratings.
South Africa compares poorly with other emerging economies such as China and India in terms of labour costs.
The average monthly salary, including overtime and benefits, is R6 400, according to Statistics SA.
By contrast, this year the official average monthly wage for a city worker in China has been 1,783 yuan and a menial entry-level factory worker could be on a third of that, albeit with food and dormitory accommodation thrown in.
Higher taxes not a viable option
Finance Minister Gordhan hinted in April the government would consider raising taxes to boost revenue and keep the budget in check.
But analysts say raising taxes would be devastating to consumer spending, putting brakes on an already-fragile economic recovery that is vulnerable to a possible global economic slowdown.
"In an environment where growth is still relatively weak and the consumer is still in a phase of recovery it's very unlikely we'll see heavy increases in income taxes," said Gina Schoeman, senior economist at Absa Capital.
"It would hurt growth and we need our households balance sheets to recover over coming quarters," she added.
Consumer spending is about 60% of the economy and it propelled growth to an average 5% between 2003 and 2007.
The economy is expected to grow by an average 3% a year in the medium term, far short of the 7% the government has said is needed to alleviate poverty and create jobs for almost half of the adult population that is unemployed.