Reacting to downgrades shows lack of foresight

The government’s decision to review forecast deficits in the national budget and so prevent debt rising sharply as set out in the recent medium-term budget policy statement is welcome. However, the fact that such a turnaround is deemed necessary a mere five weeks after the original announcement shows a worrying lack of foresight and understanding.

This change appears to have been sparked by last week’s further downgrades of our credit ratings. Rather than recognising the parlous state of our national finances, it is a last-minute attempt to preempt the downgrade of our last rating above-junk status. In this way the government belatedly hopes to avoid the sell-off of our bonds by foreigners that such a final downgrade would inevitably unleash.

The government now proposes addressing the R40bn revenue shortfall revealed in the medium-term budget through further spending cuts of R25bn and raising revenue by R15bn. These are on top of similar cuts and tax increases announced in February’s budget. Finance Minister Malusi Gigaba has stated that government is, nonetheless, also attempting to find “sustainable” ways to fund free higher education.

The required spending cuts to accommodate this will be required year after year and so cannot be achieved by deferring investment or postponing maintenance. They must come from within the core budgets of government departments, including their wage bills, and so will be painful. Many of these spending sacrifices will surely involve service delivery that government previously believed to be priorities.

That it took the credit downgrades to make the government realise the dangers of the debt-laden fiscal path is astonishing. If the Cabinet did not know the higher deficits and sharp rise in future debt would prompt this response, it was poorly advised.

The downgrades appear to have rekindled a deep-seated fear in the ANC of what happens should the debt become unsustainable. If the government’s spending becomes unaffordable it risks losing economic sovereignty to the IMF and World Bank, which in return for providing funding require changes to spending and taxes that are usually very painful and always politically costly. It was this fear that caused the ANC to make deficit reduction a key pillar of both the RDP and Gear strategies of the 1990s. The huge budget deficits inherited from apartheid were successfully reduced. In 2007 and 2008 small surpluses were recorded. Debt was halved to 26% of GDP.

However, such fears appear to have disappeared since 2008. Successive huge budget deficits increased debt to 50% of GDP and the medium-term budget policy statement predicted this would reach 61% in 2022. On top of this must be added the debt of the stateowned enterprises that has been guaranteed by government, raising its total debt obligations to 80% of GDP.

Whether the belated attempt to address the R40bn revenue shortfall will be enough to halt a final debt downgrade to junk is uncertain. The credit rating agencies are also anxious about the economy’s lack of growth, since without growth it is difficult to secure increased tax revenue. Reducing deficits restricts growth in the shortrun. The benefits take time to materialise. Supply-side measures, especially boosting business and consumer confidence, are now critical to get our economy growing.

Moreover, measures to reduce the deficit and avoid further downgrades will be completely undone if the government continues with its plans to build nuclear power stations. This could only be done with more government borrowing, possibly a dedicated foreign loan, negotiated with a much lower interest rate than rand-denominated debt. Such an option would be foolish indeed. If the rand exchange rate continues weakening, the rand value of both the loan itself and its interest payments would balloon, unaffordably.

The bottom line is that the government and the stateowned enterprises have been living beyond their means and a period of painful correction is now needed. It is good that the government has finally realised this. But it remains to be seen whether it can deliver.

WHETHER THE BELATED ATTEMPT TO ADDRESS THE R40BN REVENUE SHORTFALL WILL BE ENOUGH TO HALT A FINAL DEBT DOWNGRADE TO JUNK IS UNCERTAIN IF THE RAND EXCHANGE RATE CONTINUES WEAKENING … THE RAND VALUE OF BOTH THE LOAN …AND ITS INTEREST PAYMENTS WOULD BALLOON