I’m becoming increasingly concerned that the precipitous state of South Africa’s finances is under-appreciated within government circles. I can see why that may be the case: despite years of warnings and rating downgrades, the government continues to fund its budget deficit. In addition, 10-year bond yields are only marginally higher over the past five years. Therefore, the conclusion that seems to be drawn is that the South African government still has several years to consolidate its expenditure.
Unfortunately, this is not the case. Instead of looking only at the level of South African bond yields, we should be looking at the difference in South African government bond yields relative to the emerging market average. In 2015 (pre-Nene-gate), this was 1.5%. South Africa paid roughly 1.5% more to borrow for 10 years than the average emerging market government.
Since then local inflation has fallen by more than the emerging market average. Based on inflation alone, the spread should have compressed. Instead, it has widened and continues to get worse. After averaging 2.5% through 2016 and 2017, it briefly improved to 2.25% in 2018. As the difficulties with Eskom and the ANC’s dysfunctionality became more obvious, the spread has widened to 3.25% this year.
Added to this, the public sector wage bill has put considerable pressure on expenditure since 2009. As a result, the South African government needed to borrow R214-billion in the fiscal year ended March 2017. This has risen to R404-billion for the year ended March 2020.
Based only on the rise in South Africa’s borrowing costs relative to other emerging markets, South Africa spent an extra R2.1-billion on government debt in the year ended March 2017. This rose to R4.5-billion in the year ended March 2018, and R6.4-billion in the year ended March 2019. Given the sheer size of transfers being made to Eskom, these numbers seem relatively small.
Here is the problem. In the current year ended March 2020, the extra costs amount to R13.4-billion. Cumulatively since Nene-gate, the extra costs will have amounted to R26.5-billion on extra interest costs by March 2020. Over the life of the debt issued in the current year and previous three, South Africa will pay an extra R228-billion for political instability and lack of decision-making.
These are large numbers.
More worryingly, if no progress is made to compress the deficit in the February 2020 Budget, these numbers will rapidly get worse. There is limited room to raise taxes. Aside from a VAT hike, recent increases to personal income tax have yielded far less than expected.
We need to rein in spending. For several years, the National Treasury has tried to do this by cutting department budgets, leaving them to figure out how to deal with it. That solution has also run out of room. Several government departments run out of money several months before the end of the fiscal year – and halt payments until the start of the next year.
The only option is to address the wage bill, which has grown by R364-billion since 2006. Of this, R158-billion was for inflation adjustment, R46-billion was for new jobs and a whopping R159-billion was for real wage increases. Since there has been absolutely no increase in service delivery in that period, it seems to be money completely wasted.
Given the parlous state of the South African economy, this is not the juncture to cut jobs. The solution is to reopen the vastly over-generous three-year wage agreement signed with the public sector in May 2018 – and agree to a new three-year wage agreement that results in average increases below inflation in the next three years. This can be adjusted to provide inflation compensation for lower-paid workers – but the bulk of employees should be seeing real wage cuts. This is particularly true for those in bands 9 and higher who earn more than R500,000 a year.
If such an agreement cannot be reached, then job cuts are needed next year. The wage bill must grow slower.
Alas, there seems to be no understanding in government that action is needed in 2020. Pushing this out to the following year is not an option. As the recent Moody’s report showed, South Africa is no longer being given the benefit of the doubt. We cannot promise cuts in 2021 and hope for the markets to give us time. Without a move in 2020, the spread between South Africa and other emerging markets is likely to rise from 3.25% in 2019 to 4% in 2020.
The extra cost of debt in the year ended March 2021 will be R24-billion. That is a large number: it amounts to a 1% increase in the VAT rate. Moreover, it means that over the life of the debt, South Africa will spend an extra R366-billion on interest for the debt it has issued since 2016. That is R366-billion that could have been better spent on schools or healthcare or policing.
Cutting the wage bill will save on interest charges, not only because less debt will need to be issued, but more importantly, because it will reduce South Africa’s fiscal risk and lower borrowing costs. Ultimately, this will free up resources to spend on education or other government services.
Alternatively, the government can avoid doing anything so difficult as reducing the growth in next year’s wage bill. Instead, it can watch interest costs climb from 12% of total spending to 15% – and head towards 20%. By then one in every five rands government spends will go towards interest. If decisions are not made by next February, that reality is a very few years away. BM