South Africa is running out of money — just when the ANC needs it the most. In the past month, the two bastions of economic common sense left in SA — National Treasury and the SA Reserve Bank — have warned the government in no uncertain terms what exactly is at stake.
Early in September, in a series of marathon meetings at Spier Wine Estate, it was the turn of National Treasury to present the extremely unpalatable set of options it has for cuts to the swollen state budget. Over vintage red wine and steaks, the picture was made very clear to President Cyril Ramaphosa.
SA’s budget deficit reached a record R143.8-billion in July, the largest since at least 2004 and wider than the R115.5-billion forecast by economists. With expenses increasing and tax revenues dwindling, something has got to give. Either SA spends less, or it borrows more. The country is, quite simply, living beyond its means.
It is clear what the trade unions and indeed the majority of the government would prefer to do, especially fighting for re-election next year. Tightening the belt, particularly if that entails cutting social security spending, is simply out of the question. Pre-empting this, 10-year SA bond yield spreads have already widened from 11.50% to an eye-watering 12.4% in a matter of weeks. The ZAR has weakened from 17.50 to the dollar to around 19.
Entering the fray, last week it was the turn of the ever-erudite governor of the SA Reserve Bank, Lesetja Kganyago. In his understated, accessible way, he beautifully explained the subtleties of the international bond market and the importance of bond yields.
What is it that sets SA bonds apart from, say, those of the US? Comparing them all to slices of bread, he said that investors are happy to buy and eat those of the US plain, as they are. However, given the inherent risks associated with SA’s bread slices, they require “spreads” — perhaps some butter, or honey, or even, in desperate times, lashings of Nutella — to make them more attractive and palatable to investors. Of course, implicitly, these spreads that the government has to generously apply cost more and more money to fund.
All of which puts Ramaphosa in a difficult situation ahead of the polls next year. Either cut social benefit spending to fund higher borrowing costs and keep the deficit under control, or face yields rising even higher and the rand weakening further. Sadly, the latter simply has to be the most likely outcome, in which case investors should expect South Africa’s twin budget and current account deficits to widen even further.
In hindsight, the forecasts of a balanced budget in 2023 made by Finance Minister Enoch Godongwana in his February Budget were always hopelessly unrealistic.
“A primary fiscal surplus will be achieved in the current financial year, and this will be maintained over the medium term. This is a critical policy stance,” was Godongwana’s statement a mere seven months ago.
Now, such a delusion calls into question the quality of economic forecasting at Treasury, unless they were simply being duplicitous. If draconian cuts are not made to public sector employee salaries and social benefits, one could expect a deficit of more than 5% in 2024 and debt-to-GDP higher than 75% by the end of 2024. These are base-case Bloomberg estimates, which could even turn out to be optimistic.
Of course, then the entire system risks coming unstuck in a brutal downward debt spiral. The key is borrowing costs, as once again Kganyago’s spreads come into play. If investors sell their bond holdings given the worsening fiscal fundamentals, the yield required to entice lenders to buy SA bonds will have to go higher, thereby consuming a greater percentage of the country’s budget. This would necessitate even more borrowing, an even worse fiscal outlook, and once again, higher yields.
Of course it is clear what many in the ruling party would like to see happen. Simply put, for the SA Reserve Bank to open its cheque book and “monetise the deficit”; print money and lend directly to the government. Needless to say, Lesetja Kganyago, that voice of monetary sanity, does not even entertain such notions.
But next year his mandate will be up for renewal. Odds are that he will be kept on, or another establishment candidate from the central bank will be offered the role, such as Deputy Governor Fundi Tshazibana. However, at some point in the future the dominant political forces within the ANC could coalesce to ensure a more lenient hand is on the monetary tiller.
National Treasury is critical to the sober economic management of South Africa, but sadly, as deficits have widened and debt-to-GDP has soared, it has been shown lacking in standing up to the extravagant spending urges of the ANC. This, of course, has made the role of the SA Reserve Bank ever more essential in underpinning the economic sustainability of the entire SA economy.
It is no exaggeration to say that Lesetja is the one man standing between SA and hyperinflation, a worthless currency and eventual bankruptcy. Should the independence and conservatism of the SA Reserve Bank ever be threatened, the days of R19 to the US dollar and 12% 10-year bond yields could seem very distant memories indeed. DM