Cape Town Round Table: 6 February 2018 - The Budget, Growth And Debt

Introduction

The Helen Suzman Foundation held its first Round Table of the year on Tuesday, 6 February 2018 at 6 Spin Street in Cape Town on the theme ‘The Budget: Growth and Debt. Speakers were the HSF’s Head of Research, Charles Simkins, the HSF’s Legal Counsellor, Anton van Dalsen, and Dr Iraj Abedian, chairman and Chief Executive of Pan African Investment and Research Services. 

This report presents the content of the addresses.

Charles Simkins

Charles Simkins started off the discussion with comments on six themes:

1. Low potential growth.

The potential output of an economy represents the level of output that an economy can sustain without causing any changes to inflation. The potential growth rate is the rate of growth of potential output. A study published by the Reserve Bank indicates that the potential growth rate between 2010 and 2015 was in the 1.9% to 2.3% range and that it almost certainly fell during the period to less than 1.5%. The population growth rate in 2015 as estimated by the United Nations was 1.3% per annum, so that the potential growth rate in per capita income in that year was virtually zero. IMF projections indicate that real per capita GDP will not reach its 2014 level even by 2022. Of course, in the short run, actual growth may exceed potential growth, or fall below it.

2. The reason for low potential growth is structural.

Raising potential growth requires a whole string of microeconomic changes. We have not lacked for advice on these over the past fifteen years, from the Harvard South African growth project, the IMF, the World Bank and the OECD. We have taken virtually none of it. Good fiscal policy cannot substitute for structural reform as a means for raising the potential growth rate, but poor fiscal policy can damage growth. 

3. What are the damaging effects of poor fiscal policy?

In the contemporary South African context, it would result in:

- A rapid increase in public debt service costs. These were projected to rise by an average of 11.0% per year, compared with 6.7% for non-interest government expenditure.

- A crowding out of investment by both the public sector and the private sector. 

- The standard prescription is to maintain public sector investment at a time of fiscal consolidation, but the vested interests in the public service are against it, and it is particularly hard to do when two-thirds of government spending goes to functions responsible for realising constitutionally mandated social rights. And there are demographic pressures on both social grants and education.

- Private sector investment gets crowded out when there is an increase in government borrowing, the mechanism being higher interest rates than there otherwise would be.

4. Fiscal risks identified in the October 2017 Medium Term Budget Policy Statement.

There are:

- Macroeconomic risk. This has diminished somewhat between October and now. It could easily rise again if the 2018 budget is poorly received, as it will be if convincing progress on fiscal consolidation is not made.

- Tax buoyancy risk. Tax buoyancy is the ratio between annual growth in tax revenue and annual increase in GDP. Tax buoyancy has fallen since 2015/16, and the question is why. Developments at SARS may be part of the explanation and the Treasury announced an inquiry into tax administration and governance at SARS in November 2017. 

- New policy proposal risk. This refers to the introduction of expensive new policies at a time of low economic growth. Rapid expansion of expenditure on higher education is a case in point. So is NHI. Mercifully, nuclear is not likely to happen.

- State owned enterprise risk. This refers to forced transfers to state owned enterprises to stave off debt default, such as the R 5.2 billion grant to South African Airways in the second half of 2017. The elephant in the room is ESKOM. The way in which state owned enterprises are holding the country to ransom is outrageous. They prey on both on the taxpayer and the consumer.

- Public service wage risk. Negotiations are currently in progress. The government is offering a CPI increase and the unions are asking for considerably more. Every 1% increase in the settlement is estimated to cost R 12.7 billion in the next year. Over the last decade, negotiated annual cost-of-living adjustments have exceeded Consumer Price Index (CPI) inflation by an average of 2 per cent. 

5. Fiscal policy to support growth requires political and administrative changes.

The Treasury’s principal function is to represent the government’s budget constraint. Three political conditions are essential:

- The Minister of Finance must be competent and his words must carry political weight. Snappily clothed vacuity is not a substitute.

- The Minister of Finance must have the full backing of the President, and the President must be able to grasp and respect economic argument.

- The Treasury must be able to frame options for Cabinet decision and the Cabinet must be willing to choose from them. There is a habit to take only those decisions they are comfortable with. Reviving growth will require decisions that take the Cabinet outside their comfort zone.

Treasury officials need to be the most technically competent in the public service. ‘Cadre deployment’ among officials is always undesirable and particularly damaging in the Treasury. The ‘developmental state’ fantasy should not weaken Treasury control.

6. Conclusions

Relief at political developments and charm will bring some economic benefits in the short run, but in themselves they will not tackle a long-standing lack of seriousness about economic growth. Whether the necessary political will to reverse the situation can be mobilised is an open question. If it can’t, only windfalls can save us from economic and social stagnation.

Oh, and one thing one can be confident about is that substantial increases in taxation are coming in the budget. The only issue is how they will be distributed across the forms of taxation. Top earners, brace yourselves. You will not be alone in the contemporary world.

Anton van Dalsen

Anton van Dalsen explored the current political and economic climate as a means of understanding how we got to where we are, and what we need to focus on fiscally, in order to surmount our economic growth challenges:

1. We are in many ways at a defining moment - not only politically, but also economically.

2. In an uncertain and unpredictable economic environment, where we are now, people would rather sit on their money. One of the major constraints on economic growth has therefore been the reluctance or refusal of business to take investment decisions.

3. In this regard, have a look at the IMF growth forecasts: 0.9% growth forecast for both 2018 and 2019 - these were put together before the ANC conference last year, but they show what will happen if nothing changes. These growth forecasts are in sharp contrast to the rest of the world - as far as the rest of the world is concerned, the IMF says “Global economic activity continues to firm up ….. Global growth forecasts have been revised upward …. to 3.9%.”

4. Against this background, let’s focus on one specific part of government finance: the government debt issue - on which growth has a major impact. Less growth puts a strain on government tax revenue (there is already a R50bn shortfall this year for this reason), and increasing government debt is one way of dealing with the shortfall.

5. Looking forward to the budget on 21 February, the following are major issues:

   • To what degree will revenue cover expenditure - and here there are 2 specific questions: has expenditure has been trimmed and have taxes been raised?

   • What is the size of the deficit? And to what degree will debt increase to fund this?

   • The level of debt:

     • It’s important to consider debt expressed as a percentage of GDP. Now this sounds very dry and academic, but it is an important pointer - the benchmark danger level used by the IMF and others for developing economies is 70%.

What this says in a few words is that if your debt reaches that level, you are having to spend so much in interest payments that you have to cut essential services such as health, education etc. to be able to service the debt. In short, you are confronted with a fiscal crisis. To put it in everyday household terms, it is the situation where you are having to pay so much towards your credit card debt that you have to skimp on necessities.

In South Africa’s case, National Treasury’s own forecast last October is that the country’s debt will stand at 60% of GDP in 2020/21 (up from 50% in 2016/17) and interest payments will almost equal the national health budget at that stage. Debt at these levels run the danger of increasing quickly if there are further unexpected shocks.

- It’s important to note that excluded from the debt to GDP ratio I mentioned earlier, are the state’s guarantees for the debt of state-owned entities - these are seen as contingent, and not actual, liabilities. Most important of these by far is Eskom’s guaranteed debt of R350 billion, together with a further R200 billion in respect of independent power producers - which is effectively, Eskom exposure, since Eskom has to buy their electricity. So Government has effectively guaranteed R550bn of Eskom exposure - to give you an idea of the numbers, this total of R550bn amounts to just over 20% of total already existing government debt. (Or: 12% of GDP)

And the real danger lurking here is not that Eskom will default on it all (which is very unlikely), but that one lender calls default and brings the whole house tumbling down - since all lending agreements are subject to cross-default provisions and one lender calling default therefore entitles all other lenders to do the same.

6. So, if we take an overall view: the big danger for debt ballooning is continued insubstantial growth, especially if you have to fork out big amounts to assist Eskom. If this happens, we will be looking at getting to the 60% debt/GDP number much earlier than 2020. If that happens, alarm bells will start ringing.

7. It’s not all doom and gloom - but we have to be realistic about what faces us. Things can be righted, but what is required is:

   • firstly, a strict approach by Treasury; and

   • secondly, much greater policy certainty, leading to increased business confidence.

Iraj Abedian

Iraj Abedian spoke to four themes in his address:

1. Macro Issues

Our fiscal revenue is low and our GDP growth is stalling, however inefficiencies created during the Zuma era can be corrected. It requires putting the right people in government. The erosion of the fiscal base is not accidental, and the private sector via corporates, have been complicit.

Should we have the cabinet that we have? What is the “cost to company” of each Minister in South African? Public expenditure is driven by sum total of ethics of governance. The unchallenged use of the public purse is lamentable when it does not conform to the Ministerial Handbook, for the members of the Cabinet or executives at sub-national levels. Such expenditure is not constitutionally given or ethically neutral. What else could have been done with this money?

2. Micro Financial/Fiscal Issues

South Africa needs microeconomic changes to improve growth – it is not for a lack of advice. Over the past decade, government has been unwilling to heed advice on such changes.

A revival of growth will mean that cabinet needs to be taken outside of its comfort zone.

The country requires an “ethics audit”, where as much as 40% of public expenditure needs to be revised, refocused, and directed to the needs of the society. We shouldn’t take revenue figures as a given without interrogating the true breakdown of costs. Expenditure morality and tax morality are the two sides of the same coin.

This includes the role of corporates who in some instances are as bad as certain politicians

The Zuma era meant 8 years of looting and a consistent erosion of the tax base. The financial and fiscal control that took 12 years to build and which was destroyed in his presidency as a result, must be rebuilt. This rebuilding must happen at all levels of the state machinery – including supply chains, authorisation and tendering process. The management problem facing government exists at all levels - national, provincial, local, and also within state-owned enterprises. Fixing these deficiencies will have a feedback effect into addressing the macro issues. This means the more we manage public expenditure with probity, the more the economy responds positively and generates revenue for the state.

Even if our growth trajectory manages to stay on track, we still require a cultural shift in how fiscal management operates in order to remedy operational inefficiencies. The challenge is figuring out how to get efficiencies from limited resources

3. Zuma-made Issues

To undo the damage of the Zuma era will require strategic fiscal decisions around sustainable growth. In order for this growth to be sustainable, in the 21^st Century, we should all be able to share in it. We need:

- Reliable, competitive and efficient energy, water and ICT services (mining, banking, agriculture, tertiary university).

- A response to urban planning deficiencies – urban densification is happening without urban infrastructure. There are no long-term plans for water, roads, etc. Municipal management and planning departments must be strengthened.

- A focus on our human resources – this requires investment in public health and education. We can only have sustainable growth with matching human resources. We cannot ignore these demands because of debt constrains.

- A focus on creating a logistics environment that ensures competitive access to the market.

Conclusion

South Africa’s sustainable growth prospects are positive but the road ahead will require keen scrutiny of the relationship between the public and private sector, a focus on rejuvenating the culture, morals and ethics of management, investment in the social needs of society and a return to rebuilding what was lost under the Zuma era. Much of this, in his view, is a matter of planning, strategic decision making, and recommitment to shared values.

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Cape Town Round Table: 6 February 2018 - The Budget, Growth & Debt - Beyond The Political Noise: Structural Change Is Urgently Needed

The Helen Suzman Foundation’s Round Table took place surrounded by banners advertising a State of the Nation Address on 8 February that was not delivered. Instead, an ANC process, drawn out for over a week, has resulted in its National Executive Committee recalling Jacob Zuma from his ‘deployment’ as president of the Republic, ending in his resignation on 14 February.

South Africa’s political outlook is more positive than it was before the ANC elective conference in December, and some tangible changes have already emerged, including the new Eskom Board and South Africa’s warm reception in snowy Davos. South Africa’s deteriorating economic situation has often been attributed to political failures. Zuma’s exit was a necessary condition for economic progress. But it is by no means sufficient. Massive economic challenges remain, regardless of who is President, and South Africa’s economic recovery requires far more than a change in political leadership.

The Cape Town Round Table looked at these challenges and what will be needed to overcome them.

An indication of the economic headwind facing South Africa is that in January 2018, the International Monetary Fund forecast that the country would achieve 0,9% growth in both 2018 and 2019[1], lowerthan the October 2017 forecasts by 0.2% in 2018 and 0.7% in 2019. The World Bank January 2018 forecast was 1.1% in 2018 and 1.7% in 2019. In July 2017, the OECD projected a growth rate of 1.2% in 2018. The forecast in the October 2017 Medium Term Budget Policy Statement was 1.1% in 2018 and 1.5% in 2019. No-one expects economic growth to exceed population growth of 1.2% (as estimated by the United Nations) in 2018, and it may well be that the position will not change in 2019 either.

The risks to the South African economy are numerous. Firstly, the rising debt to GDP ratio, which is creeping towards the 70% mark that the IMF warns developing countries should not surpass. South African debt is currently projected to approach the 60% of GDP mark in 2020/2021, up 10% points from 2016/2017. Debt servicing costs eroding the government’s ability to fund economic growth generating programmes[2]. These debt levels do not include government guarantees for State Owned Enterprise debt, with direct and indirect Eskom guarantees alone running to R550 billion. There was a general feeling at the Round Table that the lack of growth-promoting structural reform at microeconomic level over the past 25 years has hindered South Africa’s economy and that the country has not taken the wealth of advice offered to it on this issue.

It follows that:

• The 2018 Budget, due to be presented on 21 February, should be an austerity budget with cuts to government expenditure as it was projected in the October 2017 Medium Term Budget Policy Statement, and increases in taxation. The rash promises made to university students in December 2017 only complicate the situation. Should the Budget be badly received, pressure on the economy will worsen. And there will be little room for a change in fiscal stance in the 2019 Budget.

• A firmer grip on public sector wages is needed. Compared with 2010, real public sector wages were 12.6% higher in the second quarter of 2017, compared with a 5.2% increase in the private sector. Expenditure ceilings will simply mean that employment in the public sector declines to the extent that wage increases rise above inflation. To a considerable extent this has happened. Public sector employment in the second quarter of 2017 was 8% lower than the peak reached three years earlier[3].

• A new president and Cabinet will need to stabilise the fiscal position, and then work hard to raise the potential growth rate from below 2% – the speed limit at which the economy can grow. If government does not pay much more attention to structural reform in support of growth than it has done between 1994 and now, real GDP per capita will continue to decline, or at best stagnate. A necessary first step is the reduction in rent being extracted by the public sector. It will not be straightforward to form the necessary political will in the face of political divisions and factionalism within the ruling party. But sustaining investor and market sentiment will require decisive action and the articulation of a new vision for the South African economy.

The Round Table did, however, suggest solutions to overcoming our current economic challenges. Panellists spoke of changing the culture of government in relation to spending, particularly on current expenditure. They also pointed to the need to rebuild financial management and control at departmental level, severely undermined over the past few years. Policy certainty could contribute a great deal, provided that it stimulates, rather than discourages, private sector growth.

In the longer term, public sector investment and policy should focus on reliable water and energy supplies, building infrastructure (with a particular focus on urban and ICT infrastructure), and skills development, which will be particularly important in light of the rise of automation and the changing nature of work.

While a change of political leadership will help, these changes require a substantial shift in the way that government does business, in stark contrast to the culture that has emerged over the past decade. This will take stricter regulation and oversight. There will also be complex political negotiations, with the public service wage negotiations a prime example.

Difficult trade-offs will have to be made in terms of where the state allocates its already constrained financial resources, with political pressures being weighed up against long term economic considerations. Furthermore, there will need to be a fundamental overhaul of the way that state owned enterprises operate, with new business models, along with a committed anti-corruption drive. Positive sentiment can only go so far without tangible and decisive action.

Rafael Friedman, Researcher, Helen Suzman Foundation

[1]International Monetary Fund. World Economic Outlook: Update 22 January 2018.

[2] International Monetary Fund. IMF IMF Executive Board Concludes 2017 Article IV Consultation with South Africa: June 2017.

[3] Statistics in this paragraph are taken from the December 2017 SA Reserve Bank Quarterly Bulletin