After a decade of weak growth and profligate spending under former president Jacob Zuma, South Africa faces a dire shortage of funds. In the face of the worst economic contraction in almost a hundred years, it is very seductive to conclude that the SA Reserve Bank should print money to support the economy and protect South Africa’s productive capacity and households.
Effectively, the SA Reserve Bank should either massively increase bond purchases in the secondary market to plug the funding gap and drive down government borrowing costs or the SA Reserve Bank should buy zero coupon bonds directly from the National Treasury, allowing the government to borrow for “free”.
There appear to be two preconditions for a country to use its central bank to finance its deficit.
First, it needs to be for a finite period to fill the gap in a crisis. It needs to be temporary. Without the end date in sight, the net result is persistent money printing – which inevitably leads to persistent currency weakness and inflation. Most countries seek to counter the inflation with price controls, which then destroys local productive capacity. This leads to a shortage of supply.
Second, in order for the money printing to be temporary, there needs to be a very plausible path back to fiscal sustainability. South Africa entered Covid-19 with a projected budget deficit for the current fiscal year of 6.8% of GDP. This was one of the largest in the world at the time. The February 2020 Budget saw no point in the next three years when South Africa would not be borrowing to make interest payments.
To remedy this situation, South Africa needs to have a tangible plan to boost economic growth (and thus tax revenues) and cut expenditure. Four months into this crisis, the government has yet to produce any progress on structural reforms. We are still deliberating options, with no signs of concrete action. A little optimistically, we are seeing common agreement from the ruling ANC party, Cosatu and SA business on some key measures, notably making it easier for business to operate, accelerating the Green Energy transition, restructuring Eskom, increasing private sector participation in infrastructure delivery and accelerating visa-free access. Agreement is good – but real progress on reforms is needed for a pick-up in growth in 2021.
It is no surprise that the government does not yet appear solidly committed to curtailing spending growth as detailed in Finance Minister Tito Mboweni’s recent Supplementary Budget. Bear in mind that the minister has not proposed much in the way of nominal spending cuts – rather the Supplementary Budget curtails spending growth and budgets on flat spending over the next two and a half years.
South Africa urgently needs to deal with the crisis that the public sector wage bill has become. In the current year, 60% of tax revenues will cover the public sector wage bill. (Last year, the wage bill accounted for 47% of tax revenues.) Public sector employees comprise 2.5% of the SA population. Let me reiterate: In the current year 60% of tax collections will pay the salaries of 2.5% of the population. Is this fair? It is certainly not sustainable.
In 2008, South Africa had a debt-to-GDP ratio of 23% and had run budget surpluses for several years. At that point, we had room to experiment with central bank bond purchases. Ten years of mismanagement later, there is no such room.
Aside from cost cutting, South Africa needs to reconsider the composition of its spending. For example, if we decide to pay a R350/month Basic Income Grant to unemployed people between 19-59, we would need to raise roughly R42-billion per annum. This equates to a 7% cut in the public sector wage bill.
Therefore, we would be cutting the wages of 2.5% of the population by 7% to pay a Basic Income Grant to 16% of the population.
Without real progress on reforms and a lower public sector wage bill, there is no way to engineer a path to fiscal sustainability in South Africa.
Indonesia became the first emerging market to venture into the central bank directly financing the government deficit this week. It has just announced that the central bank has agreed to buy government bonds equivalent to 3.6% of GDP in the primary market at below market interest rates. So far, markets have not panicked. This is probably due to the following factors:
- Indonesia’s 2020 budget deficit is projected to be 6.3% of GDP, up from earlier estimates of 1.8%. Its pandemic deficit is only as bad as South Africa’s pre-pandemic deficit.
- Indonesia’s economy grew by 5% in 2019 and 5.2% in 2018. After a -0.4% contraction in 2020, expectations are for growth of 5.4% in 2021. South Africa went into the pandemic with no ability to grow.
- Indonesia had a government debt level of 31% of GDP in 2019. South Africa’s government debt was 63% of GDP in 2019 and is projected to rise to 82% by the end of the current fiscal year.
- The Indonesian government has committed to a return to a fiscal deficit cap of 3% of GDP by 2023. Any deviation from the fiscal consolidation plan is likely to lead to an exodus of foreign capital – which owns 58% of Indonesia’s debt. South Africa is unlikely to see a deficit of 3% of GDP in the next three years. It will take at least five years even with reforms and spending cuts.
In 2008, South Africa had a debt-to-GDP ratio of 23% and had run budget surpluses for several years. At that point, we had room to experiment with central bank bond purchases. Ten years of mismanagement later, there is no such room. Ten years of persistently higher than forecast budget deficits mean that the market will not believe any promises that the central bank purchases will be temporary. Local investor bond holdings can be controlled by regulation. There is no such leverage over foreigners, who own 36.5% of South Africa’s government debt and 30% of the stock market.
After all, if South Africa is not prepared to make the reforms needed after a decade of 1% average growth and a public sector wage bill that eclipses all other spending, why should anyone believe that the country will not seek to print money to finance the budget deficit indefinitely?
As soon as the conclusion is reached that any deficit financing is not temporary, foreigners will look to sell bonds, forcing the Reserve Bank to buy even more bonds, and the rand will depreciate. Argentina, Venezuela and Zimbabwe have provided the template of what happens next. BM/DM