Truckloads of luck are needed to escape the debt spiral
SA has entered a fiscal debt spiral and only an extraordinary attempt, or luck, will get it out of it. Economists typically express and compare the state’s debt to the size of the economy or GDP.
State debt comprises mostly bonds (about 79% of total), treasury bills (10%), some other debts (1%) and foreign loans (10%). Total gross state debt should be about R3.352-trillion at the end of the current fiscal year (end of March 2020), or 65.7% of GDP.
The most obvious origin of debt is borrowing. The state spends more than it collects from its various sources of revenue. The difference, or fiscal deficit, should be about R361bn in the current fiscal year, or 7% of GDP.
At the end of the previous fiscal year the state’s debt stood at R2.788-trillion (56.7% of GDP) and the deficit in the current fiscal year is added to the debt of the previous fiscal year to get to the debt at the end of the current fiscal year.
In the current environment the deficit is the most important contributor to debt. However, since debt is usually expressed as a percentage of GDP, the size of the economy and economic growth is also important in calculating this ratio.
CRUCIAL VARIABLES
In a zero-inflation environment with zero economic growth, the state’s debt relative to GDP will increase annually by the size of the fiscal deficit.
The economy is hardly growing, which means the current deficit of 7% of GDP can be added to last year’s debt-toGDP to get to the new debt-toGDP ratio. If the economy was also growing at 7%, the debt-toGDP ratio would remain unchanged from the year before. Economic growth is therefore crucial to preventing the debt-to-GDP ratio from accelerating out of control.
A third crucial variable that affects the debt-to-GDP ratio is inflation. When calculating economic growth the effect of inflation distorts information about the size of the economy. Economic data is thus adjusted to determine the “correct” size and growth of the real economy.
However, when the debt-toGDP ratio is calculated, nominal debt is expressed as a percentage of nominal GDP. That means the nominal size of the economy will increase due to the effect of inflation, but the nominal “size” of debt remains the same — last year’s R1bn of state debt is still R1bn now (though some debt instruments are adjusted for the effect of inflation), but last year’s R1bn worth of economic activity is more than today’s R1bn worth of economic activity because of the effect of inflation.
With the current set of variables — inflation at 4.5% and debt-to-GDP at 65% — inflation alone will “reduce” the debt-toGDP ratio by nearly three percentage points, to 62% of GDP. If inflation was running at 10%, for example, the debt-toGDP ratio would fall to 59% — assuming no new debt.
TYPICAL FRAUD
The level of inflation is clearly crucial for the debt-to-GDP ratio and is a typical fraud used by governments globally to erode debt away. This is also why it is so important to keep the SA Reserve Bank insulated from political interference.
Another variable that affects the debt-to-GDP ratio is the exchange rate of the rand. Fortunately, by our estimates foreign denominated debt, at R334bn, is only about 10% of total outstanding debt.
But still, a 1% depreciation of the currency will “add” 0.1% to total debt, or about 0.06% to the debt-to-GDP ratio.
Most assumptions are for the rand to depreciate at a rate of about 5% against the dollar, which means the debt-to-GDP ratio should increase 0.32% annually from this source. But a downgrade, for example, may lead to a sharper depreciation of the rand, of say 10%, which would “add” 0.65% to the debtto-GDP ratio, about R33bn.
Other variables also affect the debt-to-GDP ratio, but the above are the most important.
Given the budget estimates of the minister and the most likely actual outcome, as well as the current economic environment of very low or no growth, a huge fiscal deficit, a depreciating currency and lowish inflation, it is clear that the state’s debt is out of control.
Since our political leaders don’t want to control state spending and hence the deficit, all we can hope for now is stronger growth — which is unlikely to materialise.
With any luck, inflation will accelerate sharply to fix the debt-to-GDP problem, but that is the kind of luck we can do without.
WITH ANY LUCK, INFLATION WILL ACCELERATE TO FIX THE DEBT-TO-GDP PROBLEM, BUT THAT IS THE KIND OF LUCK WE CAN DO WITHOUT