Opinion article by JP Geldenhuys, Lecturer: Department of Economics and Finance, University of the Free State.
The 2022 Budget was delivered this week by Minister Enoch Godongwana against the backdrop of higher inflation, very high and increasing unemployment, increasing poverty and sustained low average annual GDP growth. Budget 2022 hits many of the right notes, particularly regarding the improved state of public finances, as well as the measures that were announced to stimulate economic growth and support ordinary people. However, many uncertainties and risks remain that endanger the outlook for both public finances and growth, many of which are beyond the control of government, such as the future course of the COVID-19 pandemic, geopolitical conflict, and the tightening of monetary policy around the world, but particularly in advanced economies, as a result of persistently high inflation. Other risks to the public finances, such as poorly performing state-owned enterprises (SOEs) and local governments, and high levels of corruption in the public sector, fall squarely within the control of government. But it is debatable whether a government that is losing popular support is willing to expend the political capital necessary to address these risks.
Budget 2022 provides real (inflation-adjusted) tax relief to taxpayers, notably by adjusting income tax brackets for inflation. Additionally, there are no increases in the general fuel levy and the Road Accident Fund Levy (but there is a one cent per litre increase in the carbon tax). Social grant amounts also increase more or less in line with inflation, with the old age, disability, care dependency and war veterans grants increasing by R90 per month in April and a further R10 per month in October, while the child support and foster care grants increase by R20 per month in April. As announced by President Ramaphosa in the State of the Nation address, the social relief of distress grant was extended for another 12 months, with R44 billion being set aside. This means that National Treasury projects that almost 10.5 million people will receive the grant, valued at R350 per month, over the coming year. With the extension of the social relief of distress grant, more than 46% of South Africans now receive a social grant.
The outlook for the deficit and government debt has improved notably since the 2021 Budget and 2021 Medium-Term Budget Policy Statement (MTBPS). The consolidated budget deficit is projected to be 5.7% of GDP in 2021/22, before declining to 4.2% of GDP in 2024/25. Furthermore, the primary balance, which captures the difference between government revenue and non-interest spending by government, is projected to move from a deficit of 1.3% of GDP, to a surplus of 0.6% of GDP by 2024/25. This will be the first time that the primary balance will be in surplus since 2008/9. This development should be welcomed, because in countries like South Africa, where interest rates exceed growth rates, primary surpluses are necessary to ensure that the government debt-to-GDP ratio does not increase continuously. In other words, we need to run primary surpluses to ensure that fiscal policy is sustainable. The National Treasury is projecting that the government debt-to-GDP ratio will peak at 75% by the 2024/25 fiscal year, before decreasing gradually to 70% by 2029/30. The projected peak of the government debt ratio is lower than the peak of 78% projected in the MTBPS of October 2021, which in turn was much lower (following rebasing of GDP) than the peak of 89% projected in the 2021 Budget.
The projected paths of the deficits and debt ratio should ease concerns by ratings agencies and institutions like the International Monetary Fund about the sustainability of South African fiscal policy, which, in turn, will put less upward pressure on the risk premium on South African government bonds. Lower interest rates on government bonds, due to lower risk premia, imply lower debt service costs, which will free up resources that the government can then allocate to spending on healthcare, education, infrastructure, and so on. This is extremely important, because debt service costs (interest payments) have grown very fast in the past few years, and are expected to grow by more than 10% per year on average over the next three years. These costs already constitute almost 14% of total government spending, and are equal to about 20% of total government revenues.
Risks pertain to government revenue and expenditure
While these public finance developments must be welcomed, there are significant risks that threaten these outcomes. These risks pertain to government revenue and expenditure. The most notable of these risks, which are also discussed in the Budget Speech and Budget Review, are the following:
● The poor financial performance and high debt levels of SOEs and local governments. As in the 2021 MTBPS, the Minister again stated that it is time for ‘tough love’ for poorly performing SOEs. The 2022 Budget Speech also echoes the 2021 MTBPS in calling for the rationalisation or consolidation of some SOEs, depending on a review of their financial sustainability and the value that they create for society. Whether government has the political will to refuse further bailouts to unsustainable SOEs, and whether it will follow through on its plans to rationalise and consolidate some of these enterprises, remains to be seen.
● There are also significant downside risks to Treasury’s GDP growth projections, and therefore its revenue projections, due to uncertainties about the domestic electricity supply, geopolitical tensions, monetary policy tightening in advanced economies due to high inflation, and a possible slowdown in Chinese GDP growth. Treasury already revised its forecast of GDP growth for 2021 downwards to 4.8%, following substantial load shedding by Eskom in the second half of 2021, as well as the violence, destruction and looting that gripped large parts of KwaZulu-Natal and Gauteng in July last year.
● Higher than expected commodity prices, and higher than expected tax collections, leading to another substantial revenue windfall, cannot be expected to last in the long term.
● Given low projected growth, rates of unemployment and poverty cannot be expected to decrease substantially in the near future. These high rates of poverty and unemployment will intensify calls for a further extension of the social relief of distress grant, or, ultimately, the introduction of a basic income grant (BIG). These calls are understandable, because the unemployment rate has trended almost uniformly upward since 2009: the latest available official unemployment rate is almost 35%, the expanded unemployment rate, which includes discouraged workers, is more than 46%, while just more than one in every three working-age adults in South Africa is in paid employment. Furthermore, in his recent State of the Nation address, President Ramaphosa stated that “[i]f there is one thing we all agree on, it is that the present situation – of deep poverty, unemployment and inequality – is unacceptable and unsustainable”, thereby providing further impetus to the movement calling for the provision of income support for working-age people in South Africa. However, it should be noted that a 12-month extension of the social relief of distress grant will already add R44 billion to government spending. Further extensions of this grant, or the introduction of a BIG, will have to be funded by permanent tax increases (or cuts to other expenditure items), as alluded to in the Budget Speech (and as stated by Prof Michael Sachs of Wits University in a recent opinion piece on www.econ3x3.org).
● Projected expenditure paths depend crucially on whether the government can get public servants to agree to very low increases in the overall public sector wage bill. A Public Sector Labour Summit, to be held at the end of March, will provide greater clarity on whether public sector unions will agree to the government's proposals.
● Finally, global interest rates are likely to increase in the near future, to combat persistently high inflation, particularly in advanced economies. Increases in advanced economy interest rates will more than likely be associated with higher domestic interest rates, pushing up already high and fast-growing interest payments and debt service costs.
GDP growth rate much too low to reduce rates of poverty and unemployment
The South African economy needs to grow much faster to combat unemployment and poverty. The Minister stated that “[o]nly through sustained economic growth can South Africa create enough jobs to reduce poverty and inequality; enabling us to reach our goal of a better life for all.”
Unfortunately, GDP growth is projected to average only 1.8% per annum over the next three years. This growth rate is much too low to reduce rates of poverty and unemployment, as Isaah Mhlanga shows in a recent opinion piece at www.econ3x3.org. Government acknowledges the need for much greater investment public and private to spur economic growth. In an effort to stimulate private investment spending, the corporate tax rate was reduced by one percentage point to 27%. Government also set aside more funds for substantial infrastructure investment, which will hopefully ‘crowd in’ private sector investment. The Budget also calls for increased and streamlined public-private partnerships (PPPs) to help finance infrastructure investment, in a nod to the funding constraints that government still faces due to high government debt levels and increasing debt service costs. Finally, the Budget also echoes calls in last year’s MTBPS, as well as the State of the Nation Address, to fast-track structural reforms to speed up economic growth, via the Economic Reconstruction and Recovery Programme. Questions remain about whether these reforms can be implemented soon, and whether these reforms, if implemented, will lead to a substantially higher growth path? National Treasury’s own medium-term growth projections cast doubt about how soon and how large it expects the effects of these reforms to be.
All the right notes, but
This Budget Speech does hit many of the right notes about the need for fiscal sustainability, as well as the need for higher economic growth to alleviate poverty and unemployment. Particularly encouraging are the projected improvements in public finances, as a stable government debt-to-GDP ratio, and lower deficits, which will help to curtail the rapid growth of debt service costs, thereby allowing government to spend more on building and maintaining infrastructure, providing quality public services to South Africans and so on. However, the substantial government revenue windfall of the past few months has again allowed the government to avoid announcing its proposed permanent, explicit solutions to long-term threats to the public finances, such as which SOEs (that are not Eskom) will be targeted for rationalisation and consolidation. It is also concerning that, despite the supposed urgency and importance of curtailing the growth in the public sector wage bill, a summit with public sector employees and unions will only take place at the end of March, leaving great uncertainty about the ability of a government that is losing popular support to extract concessions from one of its largest constituencies.