Balancing growth and fiscal rigour could heal Covid wounds
The evidence is mounting that the Covid-19-induced crisis — a global as well as local economic one — will severely, even permanently, damage the fabric of SA’s economy. This brings into focus the importance of the government’s latest fiscal stimulus package. The package is a must. But it will add to the government’s debt load, which had been rising sharply even before the pandemic struck. Add to this that the crisis is obliterating tax revenue, and you reach a real eye-opener: SA, a country with emerging-market drawbacks, will soon also have to own up to a debt ratio of developedeconomy proportions.
With countries worldwide relaxing lockdown restrictions only gradually, the pandemic could cut global trade volumes by as much as a fifth, if not more, in 2020. Such a shock alone would have been enough to pitch SA’s small, open economy into recession. But on top of this there are the consequences of the hard lockdown. And tight the lockdown still is: even after the alert level dropped by one notch on May 1, about 40% of businesses remain closed, or aren’t allowed to operate fully. For such companies, the hardship now stretches into more than seven weeks. The broader growth sacrifice has already been striking: in April, for example, manufacturing activity, car exports, electricity consumption and vehicle sales all nosedived.
Unlike most other countries, SA entered this crisis already in recession. Add to that the scale of the global and local dislocation wrought by the pandemic, and real GDP could decline by as much as 10% this year.
The government’s fiscal stimulus package therefore had to be generous — although it’s not entirely as large as the often touted R500bn, or 10% of GDP. After excluding spending reprioritisations, tax payment deferrals and the contingent liability arising from the government guaranteeing the loans banks are about to extend to small and medium enterprises, its effective size only comes to about 2.5% of GDP.
Even so, the package is still large by emerging-market standards. Couple this with the precipitous decline in tax revenue caused by this year’s unusually deep recession, and the budget deficit for 2020/2021 looks set to be more than double last year’s 6.3% of GDP.
Budget deficits should start to ease after lockdown restrictions are loosened further, fiscal and monetary policy stimuli take effect, and the global economy begins to turn. But easing deficits won’t stop the government’s debt ballooning to about 90% of GDP, or about R5-trillion by 2022/2023 — a 60% jump in just three years.
Even worse, this debt ratio would be in the region of 110% of GDP if we include all the government’s contingent liabilities. And given that economic conditions will remain challenging for the foreseeable future, the risk that portions of these guarantees will be called increases, raising government debt.
But here’s the point: whichever way the government’s debt load is defined, its size in relation to GDP is now quickly approaching levels similar to those projected for many developed economies post-Covid-19.
The obvious difference, however, is that SA is an emerging-market economy, not a developed one. Developed economies will find it relatively easy in coming years to live with increased levels of public debt, with even their low economic growth almost certain to exceed their near-zero interest
rates.
For SA, however, this won’t be the case.
Consider the following rough arithmetic. If we assume an effective interest rate of about 8% per annum, an average inflation rate of 4%, and little by way of new initiatives to narrow the primary deficit (the budget deficit less interest payments), SA will have to grow by at least 4.5% per annum in real terms to stabilise the state’s debt load at about 90% of GDP after 2022/2023. This is a daunting prospect when economic growth has averaged only 1% per annum since 2014. Conversely, if growth remains pedestrian after this year’s slump, and the same interest rate and inflation assumptions apply, the government has only one remaining option to achieve debt sustainability: to swing the primary deficit into a surplus.
To be sure, even once this year’s discretionary fiscal easing measures drop out of the base and tax revenue recovers somewhat, fiscal policy will still have to tighten by about 8%-10% of GDP over the medium term to stabilise debt at 90%. This is a painful ask, just as the economy is recovering from the worst recession on record.
This (admittedly crude) arithmetic is useful to capture the two extreme options the government has to deal with its future debt problems. But in reality there’s also a third alternative.
Call it a blend of growth plus fiscal discipline. But even this route will be hard, demanding something extraordinary. For example, instead of the approach until now of merely slowing the growth rate in recurring spending, a blended approach in coming years will require specific, and at times substantial, outright spending cuts.
Tax rate increases will be unavoidable, but the pain associated with them can be lightened by pursuing initiatives such as asset sales, clamping down hard on tax evasion, restoring the effective tax collection capacity lost during the Zuma years, and notably expanding the tax base.
This can happen only if the country’s trend growth rate rises from below 1% to, say, 3%-plus, which, in turn, will require a huge push to activate overdue initiatives such as the next wave of renewable energy projects, the auction of 5G spectrum and the fast-tracking of infrastructure public-private partnerships more broadly.
Finance minister Tito Mboweni seemingly understands the value of a remedy pitched “somewhere in the middle” all too well. Recently he again reiterated the importance of “far-reaching economic reforms … to pivot to position the economy for structurally higher growth”.
And, while now is not the best of times to pursue aggressive belt-tightening, his previous remarks show he also sees fiscal austerity as an important part of a broader strategy not to compromise fiscal sustainability. Now he only needs to persuade his colleagues who are not yet on board to join. In theory at least, this should be easier now that the full extent of the fiscal challenge SA faces in the aftermath of Covid-19 is laid bare.
The urgency of having an appropriate game plan cannot be overstated. Once the pandemic has been beaten, every sovereign will be queuing up for funding. If SA fails to impress, investors will simply shy away, with consequences too ghastly to contemplate.