Trends are not Nene’s friend as he faces the nation again

Hilary Joffe

THIS week’s medium-term budget should be a time to reflect on the prospects for the economy and for the government’s finances in the medium term and beyond. It is an opportunity for Finance Minister Nhlanhla Nene to provide an update on what has changed since he last put numbers on the table in February, and on what those shifts might mean for the public purse.

And as Nene tables his second mediumterm budget, the big budgetary questions that should be asked are less about whether he will hit his targets this year and more about whether the government will be able to do what it wants to do, and deliver what it has undertaken to deliver, not just in the short term but in the medium to long term. His team at the Treasury has had to craft the budget in an environment in which global and local growth forecasts are being downgraded daily, and in which the recent turmoil in China and in commodity and currency markets has raised questions about what the world economy, and SA’s, will look like over the next decade or two.

Perhaps the biggest shift since Nene’s last outing is the recognition that the world, and emerging markets in particular, face not a cyclical but a structural downturn, which could last a very long time. To borrow an analogy from Reserve Bank governor Lesetja Kganyago, the Bible story of Joseph in Egypt tells of seven fat years followed by seven lean years. The commodities “supercycle” of 2000-08 lasted longer than those seven fat years — but based on historical trends, the lean years now could last as long as two decades.

The “commodities roller-coaster” and its implications for fiscal policy are occupying the minds of policy makers globally. It’s the focus of the International Monetary Fund’s (IMF’s) latest fiscal monitor, published last week, which finds, in effect, that most resource-rich countries didn’t save nearly enough in the fat years to get them through the lean years, nor did they take enough advantage of the good times to introduce the structural reforms that would have enhanced their ability to grow in the bad.

That’s certainly the case for SA, even though the government did take advantage of the boom years to cut debt and start saving. That created the space for it to keep spending despite the global financial crisis and the sudden sharp fall in revenue in 2008-09, and that helped SA’s economy to come out of recession quite rapidly. But much of the spending went on public sector pay and other current spending, rather than on investment spending.

And after the commodities cycle turned down from 2012, SA’s economy headed rapidly south, underperforming its emerging market peers as external woes were compounded by its own structural flaws.

The slide in the growth outlook this year has been rapid, and not only are most economists now down to 1.5% or less for this year, but the optimism about a pickup over the next two years has waned. The Reserve Bank now expects growth to rise to just 2% in 2017. That is potentially a dire scenario for Nene. By global standards, SA’s gross government debt is still relatively modest — the IMF puts it at 48.4% of gross domestic product this year. But it’s the trend that worries the rating agencies: the figure was just 25.9% in 2008 and Moody’s singles out SA as one of the few emerging markets that saw a double-digit increase in its debt burden between 2008 and 2012.

In addition, the government faces much higher debt repayments from 2017-18, because of the extent to which it borrowed its way out of the 2008-09 crisis. That makes it important that it stabilise debt by 2017-18, and Nene’s February Budget had that pencilled in, with the deficit seen coming down from about 4% to about 2% over the medium term. The government’s ability to stick to that path is crucial to its credibility. It is also crucial to halting the rapid rise in the cost of servicing the public debt, which is now more than R100bn a year.

The consolidation path depends on the government’s sticking to the expenditure ceiling it imposed in 2012. So far it has succeeded. But this year’s public sector pay increase has put a question mark over the medium term, because although the cash can be found from contingency reserves, that leaves no flexibility on the spending side. The revenue side is in question too, given what’s happened to commodity prices and to economic growth more broadly.

So far, tax receipts are holding up reasonably well and economists expect Nene will come close to hitting his deficit targets for the current year. The question is what happens next year — and in the two years after that, out to the end of the three-year medium-term framework Nene will table this week, as well as beyond that.

Nene’s growth forecasts will be closely watched. He clearly will have to revise down his forecasts. The only questions are how far, and how realistic is he willing to be? As important as the numbers themselves, however, will be the way he explains them.

Will he blame low growth and fiscal constraints on the global environment or will he zero in on the structural, domestic factors that must be fixed if SA is to have any chance of getting out its growth trap? Will he tell a story of a cyclical downturn or will he make it clear SA must start to position itself for a long stretch of structurally lower growth — and must tailor its ambitions accordingly?

The Treasury team is more than aware of the fiscal risks SA faces and what that could mean for the government’s policy ambitions. It has modelled whether SA’s current social spending is affordable in the long term without an increase in government debt, and has found that it is — but only as long as the economy can sustain average growth of 3.5%.

It didn’t raise the possibility that longterm growth could be even lower than 2% — and might well be, if SA doesn’t start fixing the flaws that deter investment and undermine economic growth. Nor did it look at how and whether, if at all, the public purse could stretch to a nuclear programme or a National Health Insurance system.

Clearly some very tough decisions will have to be made about what the government can afford in the years to come. So while Nene might be lauded this week if he meets the current year’s fiscal targets, the danger is that if he cannot persuade his Cabinet colleagues of the lean years to come, they may yet again avoid those tough decisions.

Will he make it clear SA must start to position itself for a long stretch of structurally lower growth?