This year’s Medium-Term Budget Policy Statement (MTBPS) provided another sobering but realistic assessment of government finances, especially the rapid and unmitigated deterioration in key fiscal parameters during 2020. More importantly, it revealed that, without significant fiscal reforms and an improvement in economic growth, the government’s fiscal position will deteriorate further, quickly reaching a point where an outright crisis is inevitable. This would have severe implications for financial markets as well as the broader economy.

Three years ago the MTBPS projected that by 2020/2021 government revenue would reach R1.71 trillion, the budget deficit would stabilise at -3.9% of GDP, gross debt would total R3.42 trillion, or 59.7% of GDP, and SA’s real annual GDP growth would be around 2%.

Fast-forward three years, and the reality is alarmingly different. According to Minister of Finance Tito Mboweni, government revenue is now projected at only R1.28 trillion in 2020/2021. This is R312.8 billion less than what was budgeted as recently as February 2020 and a massive R430 billion below what was envisaged three years ago. Similarly, the budget deficit has risen to -15.7% of GDP as the growth in government expenditure has outpaced the growth in tax revenue, gross debt has jumped to a record R3.97 trillion, which equates to 81.8% of GDP, and SA’s GDP is expected to decline by around 7.8%.

In simple terms, the government has borrowed a staggering R554 billion more than it forecast just three years ago. And that is without solving any of the looming debt issues in the major State-Owned Enterprises (SOEs).

This sustained deterioration in SA’s fiscal position, which has been more pronounced this year due to the unexpected and devastating impact of Covid-19, largely reflects the combined effect of three major longer-term constraints. These are: weak economic growth that has led to a persistent under-collection of tax revenue; an ongoing need to provide many SOEs with additional finance; and the sharp deterioration in the efficiency of government spending.

As an illustration of the lack of fiscal discipline, the Minister of Finance highlighted that between 2007/08 and 2011/12 government non-interest spending grew by an annual average of 14%, reflecting, among other factors, an increase in public service compensation and an expansion of social grants. Furthermore, the introduction of the expenditure ceiling in 2012/13 constrained expenditure growth, but the structural gap between revenue and expenditure has not been adequately addressed.

The Minister of Finance also made it clear that “options to stabilise the fiscus are becoming increasingly limited”. The current set of economic reforms are only expected to begin yielding results over the next several years, implying continued weakness in revenue collection in the period ahead. In addition, according to National Treasury, “narrowing the deficit and improving the composition of spending requires reductions in the growth of the wage bill, which accounts for about one-third of the consolidated budget. Salaries for civil servants have grown by about 40% in real terms over the past decade”.

South Africa’s weak economic environment

As a direct result of the Covid-19 outbreak and subsequent lockdown measures, the South African economy is expected to record its worst growth performance in recent history, with GDP forecast to decline by -7.8% in 2020, after growing by only 0.2% in 2019, ending the year in recession.

National Treasury has revised up its 2021 GDP forecast from 2.6% to 3.3%, while the growth estimates for 2022 and 2023 are little changed, at 1.7% and 1.5% respectively. These growth estimates appear fairly realistic and achievable, but highlight that the lack of vibrant economic growth – in excess of 3% a year on a sustained basis – remains SA’s reality in the short term and is the most significant constraint, especially in terms of job creation as well as a meaningful uplift in tax revenue collection. The Minister of Finance has, however, repeatedly highlighted that, should government make a concerted effort to implement the needed policy reforms, economic growth could exceed these estimates in the longer term.

Encouragingly, National Treasury does envisage a pick-up in fixed investment spending in both 2022 and 2023 after a few years of sustained contraction. (Between 2016/17 and 2019/20, total public infrastructure spending fell from R250 billion to R183 billion, or from 5.7% to 4% of GDP). Presumably this growth in fixed investment is supported by government’s current infrastructural development initiative, which appears to be gaining some traction. 

In terms of inflation, the MTBPS assumes that the average annual rate of increase in consumer prices will remain below the mid-point of the inflation target over the next three years, slowly rising from an average of 3.2% in 2020 to 4.5% in 2023. (SA’s inflation target is currently 3% to 6%, although the Reserve Bank has highlighted the need to achieve a target of 4.5%)

Update on tax revenue collection

Unfortunately, in 2020/21 government is now expecting to only collect R1.11 trillion in tax revenue. This is a downward R8.7 billion relative to the projections in the June Special Adjustments Budget and a massive R312.8 billion below the budgeted tax revenue presented in the February 2020 Budget. This large under-collection implies that total revenue will decline by -17.9% year-on-year during the current tax year vs a budgeted increase of +5.1%. As such, the tax-to-GDP ratio is expected to decline substantially, dropping from 26.3% to 22.9% This will be SA’s worst tax performance since at least 1996.

The tax revenue shortfall of R312.8 billion has been driven by two things that have significantly affected almost all categories of tax revenue. Firstly, the tax relief measures implemented to combat the economic effects of the Covid-19 lockdown, and secondly, the negative economic growth expected this year.

According to the MTBPS, the areas of tax that will be most affected are the largest tax bases, namely personal income tax, which is expected to decline by -13.9% year-on-year amid job losses, and VAT, which is expected to decrease by -16.4% year-on-year amid lockdown-related sales restrictions, a reduction in consumption and a much weaker trade outlook. Positively, corporate tax collection is one of the only tax categories that has been revised up from the Special Adjustments Budget in June, largely because of stronger-than-expected corporate profitability, especially within the mining sector. Even with that, however, corporate tax collection is still expected to decrease by a massive -26.3% year-on-year in 2020/21.

In the medium term, government tax revenue is expected to rebound quite strongly, increasing to a collection of R1.28 trillion in 2021/22, R1.39 trillion in 2022/23 and R1.5 trillion in 2023/24. While this is an improvement compared with June’s projections, these forecasts are still R232.7 billion and R217.5 billion below the projected collection at the time of the February 2020 Budget. Based on these figures, National Treasury assumes that the tax buoyancy ratio will be at historical highs following the crisis, rising from 1.2 in 2019/20 to 1.6 in 2021/22, 1.5 in 2022/23 and 1.4 in 2023/24. Not only are these estimates well above the long-term average of 1.07, but SA’s buoyancy has never been above 1.6, even when SARS was operating at its most optimal. Therefore, there is some risk that government will fail to collect the projected tax revenue in the next three years, placing further strain on its fiscal consolidation plans.

It is abundantly clear that without a sustained increase in economic growth accompanied by an increase in employment and an improvement in revenue collection and tax morality, the South African government is going to continue to struggle to meet its revenue targets. Without higher economic growth, tax collection will continue to dwindle, scuppering government’s attempts to meet its social and economic objectives.

Update of government expenditure

According to the MTBPS, government’s spending plans for this financial year remain unchanged from what was presented in the Special Adjustments Budget in June. Largely thanks to government’s reprioritisation efforts, expenditure to tackle the effects of Covid-19 is expected to result in a net increase of only R36 billion in main non-interest spending for 2020/21 relative to the February 2020 Budget. Most of the proposed upward expenditure adjustments are still expected to be spent on supporting vulnerable households and providing health and education services like water and sanitation to households and schools; personal protective equipment to schools; and continual deep cleaning of public areas.

The MTBPS proposes a slower five-year fiscal consolidation plan amid a slower-paced decrease in government spending over the medium term. Relative to the 2020 Budget, total main budget non-interest expenditure is projected to decrease by R62.9 billion in 2021/22, R92.9 billion in 2022/23 and R150.9 billion in 2023/24. While there is a general slowdown in expected spending in different departments, the consolidation efforts by government are almost entirely dependent on cutting its wage bill.

Employee compensation as a share of total spending is projected to decrease from 32.7% as estimated in the 2020 Budget to 31.3% over the medium term. This implies that, between 2020/21 and 2023/24, National Treasury estimates that government’s wage bill will decrease by R310.6 billion, mainly through wage freezes for management-level employees and much slower wage increases for other employment levels. This plan is ambitious, as its success will require buy-in from the broader public sector, including municipalities, SOEs and trade unions. It also assumes that government will be successful in its efforts to renegotiate the 2018 wage agreement, which would save R36.5 billion in 2020/21, which seems increasingly unlikely.

In terms of functions, the learning and culture function continues to receive the largest allocation of funds, mainly for basic and post-school education and training. Economic development and community development are the fastest-growing functions, at 4.6% and 4.3%, respectively, mainly due to higher growth in road infrastructure and expanded access to basic services in line with the economic recovery plan announced earlier this month. Unfortunately, debt service costs continue to be the fastest-growing expenditure item over the medium term, growing by an average of 16.1%, increasingly crowding out spending in most functions.

A few years ago, National Treasury introduced an Expenditure Ceiling to control government spending and restore fiscal discipline over the medium term. In general, the results of this initiative have been encouraging. However, the split between consumption and capital expenditure remains hugely problematic. Over the past 10 years, government has tended to increase consumption expenditure at the expense of capital projects. This clearly undermines economic growth over the longer term and is leading to the deterioration of many vital areas of service delivery, including water, healthcare and education.

The efficiency of spending has deteriorated significantly, with the Auditor-General reporting a substantial increase in wasteful and unauthorised expenditure in recent years. This, coupled with high levels of corruption, massively undermines the effectiveness of government services, negatively affecting confidence. Encouragingly, in the MTBPS the Minister announced a range of initiatives to start to more effectively control government’s spending on salaries. While this is a step in the right direction, it is not nearly enough to restore fiscal discipline.

Update on the funding of SOEs

A key constraint on the health of government’s overall fiscal position is the perpetual need to provide significant additional finance to many of the SOEs. For example, in the February 2019 National Budget, Mboweni indicated government would transfer an additional R23 billion to Eskom each year for the next 10 years to support its balance sheet. Shortly after the National Budget was released, the authorities said Eskom would require much more financial support. Consequently, government allocated an additional R26 billion to Eskom in 2019 and a further R33 billion in 2020. This has been expanded to include a further R10 billion in 2021. These bailouts, together with the underperformance of other SOEs, have contributed substantially to the acceleration in government debt.

In this year’s MTBPS, the Minister of Finance announced that an additional R10.5 billion will be allocated to South African Airways. This does not relate to the formation of a new airline or the revival of SAA, but is related to various financial obligations government has incurred as a direct result of the business rescue process.

The Minister also indicated that the Land Bank will receive R7 billion in additional funding.

Clearly there is a real risk that the other SOEs will require additional funding in the years ahead unless more meaningful measures are adopted to restructure the key public corporations.

Other policy commitments

In recent years, the government has raised expectations regarding the implementation of several ambitious projects, such as National Health Insurance. Achieving these ambitious goals is going to become increasingly problematic unless there is a substantial increase in tax revenue, and an improvement in the efficiency of government expenditure. In 2016, Minister Pravin Gordhan made the point that “the quality of government spending needs to be improved. Too much public spending is regarded as wasteful, too much is ineffectively targeted and too little represents value for money.” Minister Gordhan stressed that “fiscal resources do not match long-term policy aspirations”. Since then, government’s policy aspirations have increased, while the fiscal resources have deteriorated significantly, limiting government’s ability to close the gap between policy intention and enactment.

The rise of the fiscal deficit and government debt

The massive tax revenue shortfall of R312 billion in the current tax year has pushed National Treasury’s projected budget deficit for 2020/21 from an estimated -6.8% of GDP at the time of the February 2020 National Budget to -15.7% of GDP. The fiscal deficit is then expected to moderate to a still substantial ‑10.1% of GDP by 2021/22, -8.6% of GDP in 2022/23 and -7.3% of GDP in 2023/2024.

Correspondingly, the increased borrowing requirement for 2020/2021 is expected to push up government debt from 63.3% of GDP in 2019/20 to a massive 81.8% of GDP in 2020/21, increasing further to 92.9% of GDP by 2023/24 before peaking at 95.3% of GDP in 2025/2026. In comparison, the February 2020 Budget had projected government debt to GDP to be at 65.6% in 2020/21, rising to 71.6% by 2022/23.

Remarkably, according to National Treasury, these deficit and debt targets are only possible if government starts to implement significant fiscal reforms, especially in relation to the salary cost, while at the same time ensuring that economic growth starts to be revived. This suggest that the risks to government finances are, unfortunately, firmly to the downside.

This dire situation is highlighted by the fact that the interest cost of government debt is projected to grow at an annual average of 16.1% a year for the next three years. This means that in 2023/2024 government’s interest costs alone will consume around 24% of all tax revenue, thereby limiting the expenditure choices government can consider.

Conclusion

It is now abundantly clear that if government does not embark on a process of structural reform timeously, government debt to GDP could breach 100% of GDP within five years, setting the country on course for an outright fiscal crisis and a possible debt default. In other words, SA would face a substantial sovereign debt crisis and would have extreme difficulty financing its own spending requirements, forcing the country to seek even greater external funding that would be accompanied by a high degree of conditionality.

Ironically, in the short-term the bond market is likely to be fairly pleased with the detail in today’s MTBPS. This is partly because government did not announce any further increase in its borrowing requirement for the remainder of this fiscal year. It is also clear that the Minister of Finance strongly intends to push ahead with various critical fiscal reform measures in an endeavour to both control the overall increase in government expenditure and to increasingly alter the mix of spending away from consumption and in favour of increased fixed investment activity such as infrastructural developments.

Unfortunately, this positive view does not take account of three key concerns. Firstly, controlling government’s wage cost over the next few years to the extent that the Minister envisages is not going to be easily accomplished especially at a time when government is trying to convincingly win a local government election in 2021.

Secondly, the projected increase in tax collection over the next three years might be difficult to achieve, given that it relies on a level of tax buoyancy that the country has never been able to sustain.

Thirdly, there is a clear risk that other SOEs will require additional government support over the coming years. This could effectively undermine valiant efforts to control the salary cost.

Overall, the deterioration in government’s fiscal position in recent years, including the rapid and alarming increase in debt, is especially damning considering the deterioration in SA’s socio-economic conditions, sustained low economic growth, record high unemployment, a record low savings rate, systematic downward revisions to the credit rating, regular electricity outages, a fragile water supply, the deterioration in public sector health and poor education outcomes.

Ultimately, there is no substitute for higher economic growth in resolving SA’s unfolding fiscal crisis. This can only be achieved through a concerted and co-ordinated effort to lift business and household confidence to improve private sector fixed investment, skills development and productivity – all of which is lacking in the MTBPS.