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Buy now, pay later strategy endangers future growth

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Picture: Jairus Mmutle / GCIS / Taken on November 1, 2023 – Guardians of the public purse, from left, SARS Commissioner Edward Kieswetter, Finance Minister Enoch Gondongwana, Deputy Finance Minister David Masondo and Director-General Duncan Pieterse at the tabling of the Medium-Term Budget Policy Statement in Parliament on November 1. Will the 2024 Budget speech present a viable pathway to long-term, sustained, and inclusive growth? Very doubtful; you cannot ‘buy’ economic growth via populism, says the writer.

By Andre Roux

The annual Budget speech is, at the best of times, a statement of intent in which economic and fiscal prudence competes with political expedience. When a country’s overall macro-economic and fiscal position is sound, it is relatively easy to accommodate a populist agenda without incurring high-opportunity costs.

When, however, economic conditions are negative and the fiscal cupboard is almost bare; and the ruling party is on the verge of contesting a general election in which, for the first time, it is no longer guaranteed an outright majority, the nation faces a potential lose-lose situation. This is a perilous situation that provides the scaffolding for the 2024 Budget Speech.

How and why did we reach this state of affairs?

The first 15 years of the post-1994 democratic era were generally fruitful and even triumphant. The economic growth rate was consistently positive, the Constitution was held in high esteem, the autonomy of our democratic institutions was upheld, foreign financial inflows grew in both magnitude and frequency, the lights stayed on, and the country’s stock of social capital appreciated.

The next 15 years have been less glorious (the “lost decade” might soon become the “lost two decades”). A recent McKinsey analysis describes South Africa as a “slow grower” by virtue of the country having consistently underperformed Africa’s average economic growth rate since the beginning of this century.

Along with this, socio-economic development has all but stalled, the unemployment rate is disconcertingly high and load shedding has become the default expectation. Infrastructure and transport obstacles have intensified, poverty is still ubiquitous, the income and wealth gap is the highest in the world, and several democratic institutions have suffered from inept leadership and/or state capture.

External forces

To be sure, as a small open economy, South Africa has been on the receiving end of external forces such as the 2008/09 “Great Recession”, fluctuating commodity prices, and the pandemic-induced 2020 global recession. The same applies to many other economies, however, it would be naive to absolve the country from any blame. In fact, these external forces probably served to accentuate pre-existing domestic shortcomings.

The latter are numerous, widespread, and persistent. For instance, a malfunctioning labour market is fundamentally unable to provide sufficient jobs for the rapidly growing labour force; while the structural imbalance embedded in the country’s economically active population (a shortage of skilled labour that co-exists with a surplus of unskilled, semi-skilled or inappropriately skilled labour), not only entrenches structural unemployment, but also compromises economic growth and development via poor productivity growth.

Other fundamental enabling factors, such as economic infrastructure, are inadequate and, in some cases, in a state of disrepair.

Account deficits

Meanwhile, the various stakeholders in the economy (for example, big business, small business, government, organised labour, civil society) seem to be working at cross-purposes, often pursuing their own agendas at the expense of others.

Furthermore, during this century several shortages and deficits have accumulated. On balance, the total domestic demand for goods and services exceeds the total domestic production. Consequently, apart from a couple of years, South Africa has recorded current account deficits since the mid-1990s.

This is partly indicative of the fact that we still rely heavily on natural resources/commodities as a major source of export revenue while failing to industrialise (add value ourselves) to earn potentially far more meaningful volumes of foreign exchange.

Conversely, this means that a substantial proportion of our foreign exchange reserves are used to pay for manufactured imports. South Africa’s notoriously low gross savings rate inhibits our ability to finance gross fixed capital formation – a condition necessary for future growth.

Deficits

International financial inflows, which typically compensate for low domestic savings, have been volatile, sporadic, and, at times, opportunistic. This, in turn, is one of the major explanations for the volatile performance of the rand exchange rate since 2000.

One of the most visible deficits is that recorded by the government. For more than a decade the Budget shortfall (the gap between government spending and government revenue) has been more than the generally accepted limits.

Consequently, the government’s gross debt-to-GDP ratio has ballooned from a more than respectable 27 percent in 2007 to above 70 percent. The latter is not extraordinarily high or unusual by world standards.

What is striking, however, is the speed at which the ratio expanded. Even that would be forgivable if the debt incurred had been used to finance fixed investment (such as infrastructure) – a well-known engine of future economic growth.

Alas, a sizeable portion of the debt has been used to partly finance current government expenditure (notably civil servant salaries and wages, various social grants, and interest payable on existing government debt). This approach, which is akin to “buying now, and paying much later” fails to create real wealth, and merely leaves in its wake a long-term obligation on future taxpayers to repay debt and interest.

In his November Medium-term Budget Policy Statement last year, the finance minister showed that the estimated spending on debt service costs over the 2024/25-2026/27 period will total R1.267 trillion, or R1.2 billion a day. This is only 14.5 percent lower than the amount budgeted for learning and culture, and 1.5 times bigger than the health budget. Meanwhile spending on civil servants’ remuneration is the equivalent of 15 percent of GDP – one of the highest ratios in the world.

All of this brings us neatly back to the rather blunt realities facing the finance minister in preparing and presenting the 2024 Budget speech. From a macro-economic and fiscal sustainability perspective, it is imperative that the Budget deficit be slashed for a number of years to first arrest, then stabilise, and eventually lower the government debt ratio. Moreover, any new debt should be used to finance productive, wealth-creating expenditure. There are two fundamental ways of narrowing the Budget deficit – spend less, and /or generate more tax revenue.

It is on the spending side that things start getting politically tricky. The social relief of distress grant, which was introduced to provide temporary financial relief to those left destitute by the Covid-19 epidemic, appears set to become a permanent feature for the foreseeable future.

There are even talks of expanding the reach of the grant. The freezing of civil servant salaries this year would be tantamount to political suicide. Then, there is a growing impatience to see evidence of the implementation of the National Health Insurance system. Of course, the elimination of wasteful, unproductive, and unaccounted spending would go a long way towards slowing down government spending, but the potential benefits will not be immediately apparent. All of this is in addition to the normal areas of spending needed to keep the wheels turning.

Taxation

The insipid economic growth expectations for the next year or two (possibly averaging 1.5 percent) imply that the organic growth in the tax base will be very slim. No doubt the Receiver of Revenue (Sars) will be urged to improve its tax collection performance, but there is a good chance that there will still be a shortfall.

This leads to the unfortunate conclusion that at some level, tax rates will have to be raised. The lesser evil here may be a one percentage point increase in the VAT rate, although this may be perceived in some circles as an unfair additional burden on especially poorer households, and it may slow down spending by an already battered and bruised consumer public (consumer spending accounts for 60 percent of the GDP). A convenient political ploy would be to introduce some form of a wealth tax – redistribution of wealth via the tax system.

‘Wild card’

There is an interesting wild card that the minister might play – the Gold and Foreign Exchange Contingency Reserve Account. This account contains unrealised profits or losses on the foreign exchange reserves that result from exchange rate fluctuations. Any such gains or losses are owed to/defrayed by Treasury.

The value of these reserves is almost R500 billion. Technically, therefore, there is a case to be made for Treasury to use all or part of the account to narrow the Budget deficit or pay off some of its debt. This would obviate the need to slash government spending or raise the tax burden.

Again, from a political vantage point, using this vehicle this year would be delightfully serendipitous. It might also, however, be opportunistic and risky. If, in future, losses are incurred on this account, Treasury would be held liable.

Furthermore, by using these contingency reserves, the country’s level of foreign exchange reserves may drop to levels too low to serve as a meaningful buffer against sudden and significant currency shocks.

Conclusion

Will the 2024 Budget speech present a viable pathway to long-term, sustained, and inclusive growth? Very doubtful; you cannot “buy” economic growth via populism.

Will it entice the majority of voters to cast their ballots in favour of the ruling party? It might be a case of “too little, too late”.

Will it put extra buying power into the wallets of beleaguered consumers? Very unlikely.

Will foreign investors and financiers scramble to invest in the country? Improbable.

All in all, the Budget speech runs the risk of validating the adage that “you can’t be all things to all people”, and attempting to do that merely delivers compromises that leave everyone frustrated, disgruntled, and hanging in limbo.

Prof Andre Roux is an economist at Stellenbosch Business School