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For more than a decade, South Africa’s economy has had disappointing growth. Over the same period, government has been borrowing at the rate of over R250 billion a year. These two trends are linked: slow economic growth has reduced tax revenues even as government spending, especially on public servants’ salaries, has grown rapidly. Now, having hit more than R3 trillion (and climbing), the weight of our debts is dragging economic growth even lower.
The main reason for the explosion of public sector debt is that in the aftermath of the global financial crisis in 2008, government responded by ramping up spending to support the economy, a strategy that worked in the short term. But instead of applying a temporary stimulus, spending growth was driven by an expanding and increasingly better-paid public service. The result was a large structural increase in spending that might have been affordable had growth returned to pre-crisis levels. It never did, however, and government failed to respond quickly enough to declining growth. The result is a large, persistent gap between spending and revenues. That gap is filled by borrowing.
All that borrowing would not be a problem if it had been used to build assets and economic capabilities that would generate future incomes that could then help pay it back. That, however, has not been the case: it has been spent on power stations that don’t produce power, a system of public transport that transports fewer and fewer people, and schools that produce hundreds of thousands of under-educated young people.
Debts raised to pay for activities that don’t create new revenue streams are unaffordable, and impose burdens on tax-payers who have to pay them back out of paycheques that are not growing.
Three options
One of the key determinants of whether debt is affordable is how it stacks up against a country’s GDP. At more than 60%, SA’s ratio of debt to GDP is not exceptionally high. It is, however, rising quickly because all the critical variables that determine the trajectory of this ratio are unfavourable: the value of outstanding debt is already large, and creates high debt service costs; we borrow more than we spend on debt service costs; and the interest we pay is higher than the rate of economic growth.
In the face of these unfavourable trends, government’s options are increasingly limited. If it does nothing, debt service costs will continue to rise. Lenders will become increasingly wary of lending money, and interest rates will rise. Rising interest rates, and deepening concerns about the sustainability of public finances, will reduce investment. And growth will slow.
SA must forge a different path. Government must reduce its need for borrowed funds and implement a range of reforms to spark growth.
South Africa has three options with which to shape the policy agenda for years and decades to come. These are inflation; fiscal consolidation through higher taxes or lower spending (or both); and faster economic growth.
To be fair, government has made some gestures towards fiscal consolidation in recent years. It has capped public spending growth (albeit at a level that is probably too high), and it has raised taxes (including, most controversially, VAT). But this has not worked. Apart from anything else, slow growth and the collapse of SARS have meant that raised tax rates have not generated the revenues expected.
More downside surprises?
Spending growth has slowed, but still exceeds the rate of growth of the economy, and this must change if we are to have any chance of achieving fiscal sustainability.
Unfortunately, however, fiscal consolidation it is unlikely to be enough. What we really need is more economic growth. This is the most viable option to achieve a more sustainable footing for public finances. Growth and its prerequisites must be the country’s top priority. However, growth must not be driven by nor accompanied by more public spending.
Responding to these challenges is going to require urgent action on a range of fronts. These must include fixing key state institutions damaged by state capture and widespread corruption, reining in spending, improving tax collection, fixing failing state-owned entities, allowing some of them to fail if they cannot be fixed, re-thinking the state-owned enterprise sector as a whole and the size of SA’s state and how to maximize the role of the private sector and competitive markets, and implementing growth enhancing reforms.
The bottom line is that the country must deal with the fiscal crisis as low growth and the public finance crisis is interrelated. The longer we wait the harder the choices. Courageous, determined leadership is required and risks need to be taken now.
South Africa is in a profound and deepening economic crisis. Growth has disappointed for ten years and as the poor growth figures for the first quarter of 2019 show it still has the capacity to surprise on the downside.
Ann Bernstein is executive director of the Centre for Development and Enterprise. This article is based on a new CDE report, Running out of Road: SA’s public finances and what is to be done, available at www.cde.org.za/.
