South Africa’s Fiscal Cliff Barometer

Introduction

This paper looks at the danger of a looming fiscal cliff facing South Africa. Initial research on the fiscal cliff (Rossouw et al, 2014) assessed social assistance payments and compensation of civil servants to calculate the point where this expenditure will absorb all government revenue.

As the interest burden on government debt developed into an additional concern since 2014, the fiscal cliff is re-defined in this paper as the point where social assistance payments, civil service remuneration and debt-service costs will absorb all government revenue. The earlier research on the matter is restated in this paper to cover these three concerns. The calculation of the barometer commences from 2014, i.e. when pressure from all three components rises.

The 2018 Budget has shown that the compensation of civil servants plus social assistance payments plus debt-service costs will amount to 70.4% of the main budget revenue in the 2018/19 fiscal year (2018 Budget). This is a considerably larger burden than the comparable ratio of 55% in the 2007/08 fiscal year.

At the same time, the domestic economy is suffering subdued growth, which implies that government revenue is under pressure. Historically in South Africa, government revenue growth shows a close correlation with nominal growth in the gross domestic product (GDP), as is clear from the figure below.

REGIME RESTRUCTURE

Subdued growth since the international financial crisis of 2008 shows that South Africa cannot continue with the same fiscal policy and the same type of regime as before. From the 20th and 21st centuries South Africa has had three regimes, namely the British imperialists who ruled from 1902 to 1909; the Afrikaner elite who ruled from 1910 to 1993; and the African elite who ruled from 1994 to the present. The objective common to all three regimes has been to exploit South Africa’s vast mineral resources for their benefit and that of their international partners through the use of cheap black labour. This model has now reached the end of its usefulness and a different political construct for a successful economic performance is necessary.

South Africa therefore needs a new, fourth political regime that should focus on:

  • The education, health care, transport and electric power supply systems, which should support a new paradigm in South Africa, namely a reliance on knowledge and skills, rather than the mining and export of raw materials;
  • Public services, including the role of traditional leaders, must be reconfigured to serve the people;
  • South Africa’s economic relations with its Common Monetary Area (CMA), Southern African Customs Union (SACU), Southern African Development Community (SADC) and Common Market for Eastern and Southern Africa (COMESA) neighbours must be renegotiated and restructured, as the current structure (particularly through the SACU revenue-sharing agreement) places an undue burden on South African taxpayers;
  • Trade and investment relations with non-African partners must be renegotiated; and
  • The economy must be restructured to be more investment-driven rather than consumption and finance-driven.

As a starting point, discussions must take place among the South African government and the country’s key economic actors. These are the Chamber of Mines, AgriSA, the Banking Association of SA, the Steel and Engineering Industries of Southern Africa, the Manufacturing Circle Labour Federations, universities and professional associations and foreign multinational corporations operating in South Africa. In today’s world no country can industrialise without the full participation of the main stakeholders in its private sector.

For South Africa to overcome its economic and political malaise of low growth and corruption, it needs to address lack of competition between firms in the domestic economy and lack of competition between political parties in the political arena. Only competition in the economy will pull South Africa out of its mineral resource dependence for exports and drive exports for manufactured products. This is what will lead to greater industrialisation.

Only real competition for power between political parties will overcome the underperformance in the public sector and public sector corruption. The electoral dominance of the ANC means that corruption within the ANC government is cost-free as there is not a similar size party to punish the ANC for corruption.

Challenging the ANC has to entail a feasible structure in opposition parties. The ruling ANC holds 249 seats (62.3%), while the main opposition party, the Democratic Alliance, holds 89 seats (22.3%) in Parliament. The remainder, i.e. 15.4% (62 seats), are held by no fewer than 11 different political parties. This construct does not allow for a serious challenge to the ANC’s governing role in the near future.

There is an iron law for African liberation movements such as the ruling ANC: After 15 to 20 years in power their electorate starts to abandon them because they fail to deliver on the promise of creating prosperity for the masses by restructuring the colonial or neo-colonial economy. Instead, leaders of liberation movements get themselves incorporated into the inherited colonial or semi-colonial elites. In the case of South Africa, it seems that this iron law has some slippage: The best change for a serious political challenge to the ANC will be in the 2024 election, i.e. 30 years after the first democratic elections.

The challenge facing any new government that replaces the ANC (or perhaps the new ruling faction in the ANC in replacement of the Zuma administration) is to ensure the adoption of new inclusive development policies. At the same time the new government has to avert the looming fiscal cliff facing South Africa. The fiscal position is under pressure from both the revenue and expenditure sides, thus pushing South Africa closer to the fiscal cliff where the compensation of civil servants plus social assistance payments plus debt-service costs will exceed 100% of main budget revenue.

 

FISCAL ANALYSIS

After the democratic elections in 1994, the new ANC government in South Africa faced a tight fiscal position. It is indeed true that the financial sanctions against South Africa, advocated by the ANC in exile, had the desired effect: The fiscal position of the South African government was particularly precarious. The ANC turned this around successfully after 1994 and can do so again if corruption is eradicated.

In the 1993/94 fiscal year, the South African government’s deficit before borrowing amounted to 5.6% of GDP (SA Reserve Bank, 2013:33; see also Calitz, Du Plessis and Siebrits, 2011:8). Sustained economic growth after democratic elections in 1994 and in the period up to the financial crisis resulted in a considerable improvement in the fiscal position of the South African government. By 2006/07 the government had a surplus of 0.7% of GDP of income over expenditure (SA Reserve Bank, 2013:34). At the same time government debt declined to 23% of GDP (Calitz, Du Plessis and Siebrits, 2011:8). This fortuitous position could not be sustained after the international financial crisis of 2008, as the South African government recorded substantial deficits in expenditure over revenue with a concomitant increase in government debt. During the same period, South Africa saw a change within the ruling ANC, with the corrupt Zuma administration taking control in 2009. Corruption contributes significantly to South Africa’s poor economic performance.

In the calculation of the affordability of the government sector (central and provincial) in South Africa, it is important to note that the country does not have unlimited capacity to borrow. With limited borrowing capacity, the focus in fiscal prudence should be on expenditure restraint and the sources of revenue.

Government borrowing (i.e. the difference between revenue and expenditure) can be considered in different ways. One guiding principle is that borrowed funds should only be used for capital projects which will improve productive capacity, thus contributing to economic output and the capacity of the country to service such a debt commitment.

Another consideration is the borrowing guideline embodied in the Maastricht conversion criteria of the Euro Zone countries, i.e. 3% of GDP. This borrowing guideline is generally accepted as a standard benchmark for assessment of annual government deficits. Nevertheless, De Grauwe (2009) states that the Maastricht benchmark has “… very little to do with economics, and very much with politics …” On this basis, the budget deficit of the South African government should not exceed 2.5% of its GDP, as 2.5% is currently the country’s long-term potential output growth ceiling (Anvari et al, 2014). The only way to break this binding constraint is through a regime change advocated above.

Social grants and the provision of free services (housing, water, sewage and electricity) alleviates poverty and addresses South Africa’s skewed income distribution, but at the same time it aggravates the country’s fiscal pressures. Bosch et al. (2010) showed that South Africa’s Gini coefficient decreases from 0.71 to 0.59 when social grants and the provision of free services are taken into consideration in the calculation of income distribution. Social grants are the largest of these forms of assistance. The initiative to expand social grants was announced in the Budget Speech of the Minister of Finance for the 2002/03 fiscal year (Manuel, 2002) and subsequently grant beneficiaries increased from 4.2 million in 2002 to 18 million in the 2018/19 fiscal year (see McEwen and Woolard, 2015 on the annual growth in beneficiaries since 2002).

In the period since the global financial crisis of 2008, civil service employment and the compensation of civil servants increased rapidly (see Breytenbach and Rossouw, 2013 on this matter). The number of civil service employees increased from some 1.3 million at the start of 2008 to more than 1.5 million by 2016 (SA Reserve Bank). This contributed to sharp increases in the compensation of civil servants, rising from R195 billion in 2007/08 to R587.1 billion in the 2018/19 fiscal year. Treasury expects this value to rise further to R677.3 billion by 2020/21 (2018 Budget).

Owing to increased borrowing by the South African government, evidenced by the increase in the deficit before borrowing in consecutive fiscal years and by the increase in government debt as percentage of GDP, the interest burden on government debt has grown substantially. In nominal terms the debt-service cost ballooned from around R52.9 billion in 2007/08 to R187.8 billion in 2018/19 – that is roughly triple the amount in the scope of a decade. Treasury estimates that it will reach as much as R223.9 billion (or 14.5% of government revenue) by the end of the medium term forecast period (i.e. 2020/21).

This increased fiscal pressure leaves the options of higher taxes to increase government revenue, or lower government expenditure. It is therefore necessary to assess future economic growth prospects and the economy’s growth potential to estimate government revenue. An econometric model was used to forecast government revenue expectations. The specifications of the model are available from the authors.

By back testing the model it is evident that the modelled values (Model results) has a good fit to the actuals (REV_actual) which makes it an acceptable forecasting tool. See Figure below.

Jannie 1.png

 

(Government revenue forecast: model fit. Source: Own calculations)

Owing to sustained lower economic growth, government revenue is therefore under pressure. As a result, continued growth in expenditure on compensation of civil servants, social grants and growth in interest of government debt pushes South Africa closer to the fiscal cliff (see Rossouw, Joubert and Breytenbach, 2014 on this matter).

Since 2008 these three disconcerting expenditure trends increased substantially as percentage of total government revenue. Compensation of employees remains the heavyweight amongst the three and rose from 34.5% of revenue in 2008 to an alarming 46% in 2018. It remains to be seen if the tapering in this item (as evident from the Treasury’s budget forecasts) will materialise. Debt-service costs overtook social assistance payments as a percentage of tax revenue during the 2016/17 fiscal year. It rose from 9.4% of revenue in 2008 to just below 14% by 2018, while social assistance rose from 11% in 2008 to 12.6% by 2018.

The growth trend in these expenditure items at different periods are used to calculate the fiscal cliff cut-off point, i.e. the point where these three expenditure items account for all government revenue if expenditure growth trends since 2008 are retained, and the fiscal cliff barometer. This is shown in the figure below for 2014, 2016 and 2018, respectively.

The fiscal cliff barometer is calculated as follows:

Barometer =         [1-(years to cliff/total years forecasted) ]     (Equation 1)

Equation 1 essentially calculates the probability of an event happening or not. The barometer values can theoretically range from one to minus infinity, that is [), as the years left to the cliff materialising goes from immediate (zero years left) to a long period (possibly infinity). However, in practice only values between one and zero need to be taken into account as a value of zero indicates that the years to the cliff equals the total years of forecast. In summary, a high value (e.g. 0.9) will indicate a high probability of the fiscal cliff being reached, while a low value (e.g. 0.3) will indicate a low probability of the fiscal cliff being reached. Also important in the above equation is that the formula is able to take into account rolling forecast periods, which makes it more dynamic.

Applying Eq.1 to the three data points indicates that the fiscal cliff barometer declined from 0.717 in 2014 to 0.119 in 2018 (see Table below). This notes a marked improvement of the likelihood of the cliff not materialising. However, two things need to be taken into consideration. First, the model used for forecasting is sensitive to changes in assumptions, therefore even minor changes could materially influence the outcome of the model (especially when forecasting over long periods, in this case 30 year plus, into the future). Secondly, even though the situation improved, a value of above zero (i.e. 0.119) indicates that the cliff will still materialise within the forecast period, albeit at a later date. Nevertheless, the government took steps since 2014 to avert a fiscal cliff.

Table: Fiscal cliff barometer for 2014, 2016 and 2018

 

Year Years to cliff Total years forecasted Barometer
2014 13 46 0.717
2016 27 44 0.386
2018 37 42 0.119

Source:       Own calculations

Jannie 2.png

(Figure: Fiscal cliff cut-off projections for 2014, 2016 and 2018. Source: Own calculations)

 

This figure depicts the total of the three expenditure items (social assistance payments, compensation of employees and debt-service costs) as a percentage of government tax revenue. It is evident that there has been a downwards shift in the lines, from 2014 to 2016 and again to 2018, indicating that the probability of the fiscal cliff materialising has declined. However, as indicated with the barometer values above, it is evident that the cliff is still on the horizon, even though it has been pushed back a few years into the future. There is no room for complacency, thus confirming the importance of the economic restructuring argued above. Without the restructuring, we are mortgaging the future of the children of South Africa.

 

CONCLUSIONS

Subdued economic performance since the financial crisis of 2008 places the fiscal position of the South African government under pressure. The model used in this paper confirms that subdued growth in government revenue will continue for some time. This limits the ability of the South African government to introduce new expenditure initiatives, for instance a nuclear power generation programme or national health insurance.

The fiscal cliff remains a clear and real danger looming for South Africa. Steps to avert the fiscal cliff have been taken by the South African government, but the fiscal cliff barometer nevertheless shows that the cliff remains a clear and present danger. This leaves no room for complacency in government’s fiscal policy approach, particularly in respect of social assistance payments, civil service remuneration and debt-service costs.

South Africa can only overcome this malaise by embracing a new fourth political regime to restore a faster economic growth trajectory. In the period running up to successes being reaped from this new regime, the country should avoid a fiscal cliff.

By Moeletsi Mbeki, Jannie Rossouw, Fanie Joubert and Adèle Breytenbach

This article originally appeared in New Agenda Issue 70.  For full copy of this edition subscribe here. 

REFERENCES

 

2018 Budget. Budget Review 2018. National Treasury: Pretoria.

2017 MTBPS. Budget Review 2017. Medium-term Budget Policy Statement. National Treasury: Pretoria.

Anvari, V., Ehlers N. and Steinbach, R. 2014. “A semi-structural approach to estimate South Africa’s potential output.” South African Reserve Bank Working Paper Series. WP/14/08. November. SA Reserve Bank: Pretoria.

Bosch, A. Rossouw, J. Claassens, T. and Du Plessis, B. 2010. “A second look at measuring inequality in South Africa: a modified Gini coefficient.” School of Development Studies, Working Paper No 58. University of KwaZulu-Natal: Durban.

Breytenbach, A. and Rossouw, J. 2013. “’n Ontleding van vergoedingsneigings in die Suid-Afrikaanse staatsdiens, 2005 tot 2012.” Tydskrif vir Geesteswetenskappe. Jaargang 53:(4). Desember.

Calitz, E, Du Plessis S and Siebrits, K. 2011. “An alternative perspective on South Africa’s public debt, 1962 – 1994.” SA Journal of Economics.  Vol 79, No 2. June.

Calitz, E, Du Plessis, S & Siebrits, K. 2013. “Fiscal sustainability in South Africa: Will history repeat itself?” Stellenbosch Economic Working Papers: 07/13, April. University of Stellenbosch: Stellenbosch.

De Grauwe, P. 2009. The politics of the Maastricht convergence criteria. 15 April. Available at http://www.voxeu.org/article/politics-maastricht-convergence-criteria Accessed on 11 November 2015.

Manuel, T. A. 2002. Budget Speech. National Treasury: Pretoria.

McEwen, H. and Woolard, I. 2015. “The Changing Dynamics of Child Grants in the Context of High Adult Mortality in South Africa: a simulation to 2015”. SALDRU, University of Cape Town: Cape Town. Available at http://www.plaas.org.za/sites/default/files/publicationspdf/Woolard_McEwen.pdf Accessed on 9 February 2016.

Rossouw, J., Joubert, S. J. and Breytenbach, A. 2014. “Suid-Afrika se fiskale afgrond: ’n Blik op die aanwending van owerheidshulpbronne.” Tydskrif vir Geesteswetenskappe, Jaargang 54:(1). Maart.

SA Reserve Bank. 2013. Government Finance Statistics of South Africa 1994 to 2012: Supplement to the South African Reserve Bank Quarterly Bulletin. March. SA Reserve Bank: Pretoria.

SA Reserve Bank. Various Quarterly Bulletins and other non-published data sources.

 

 

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