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South Africa’s fiscal squeeze: warning signs ignored for too long

An analysis of South Africa’s current economic crisis which has put the country on the path of fiscal unsustainability was recently published by renowned economics professor Ricardo Hausmann and a number of co-researchers.

The paper shows clearly that South Africa embarked on an unsustainable fiscal trajectory over the last decade. Specific attention is drawn to the fiscal pressures coming from unsustainable growth in civil service remuneration and social grant expenditure over the period under review.

At the same time, economic growth in South Africa underperformed. Over the past decade, the trend in actual economic growth declined. In addition the country’s full potential economic growth rate also declined from around 2,5% per annum to around 1,5%.

South Africa clearly faces a serious fiscal dilemma and hard choices. The relevant question is: Who should have listened and who should have cared in the period running up to the current fiscal crisis?

The answer, as we set out below, encompasses many culprits. This includes trade unions who demanded too large civil service remuneration increases and those in the executive who granted these increases. The National Treasury is also on the list. It repeatedly overestimated annual economic growth and tax revenue. And so is parliament: its structures failed in their oversight role.

The culprits

The impact of extensive growth in civil service remuneration and social grant expenditure on the country’s fiscal sustainability was hidden for many years in unrealistically high annual growth projections used by the National Treasury in the annual budget documentation.

This is evident from a review of budget documentation of successive years published by the National Treasury.

Both of us are part of the Fiscal Cliff Study Group, an informal group that has been assessing fiscal sustainability since 2013. We warned against this practice on numerous occasions, particularly in submissions to the Standing and Select Committees on Finance of Parliament.

These warnings were at first brushed off as being alarmist. But they were confirmed over time, as evident from various Budget Reviews.

Revenue and expenditure estimates were based on unrealistic projections, leading to a compounding error effect. Lower than estimated revenue figures became the norm. At the same time expenditure continued to grow unabated. This resulted in a widening of the deficit before borrowing and in government debt as a percentage of GDP. More realistic assumptions for government revenue budgets should have been adopted earlier, thus limiting systemic errors in budget assumptions.

Over the same period the number of social grant recipients increased. With the inclusion of the Covid-19 grants recipients, more than 30% of South Africans are direct beneficiaries of some form of social assistance.

We recognise the important role of grants for poverty alleviation. But it would be negligent to not, at the same time, highlight the heavy burden this places on the already overstretched fiscus, and on taxpayers. It leaves no room for further permanent increases in social grants.

A related problem is that grant payments crowd out investment spending by the government. The focus in fiscal planning shifted to the continued funding of consumption expenditure. Warnings about this development were also ignored.

The paper by Hausmann and his colleagues also highlights the impact of civil service remuneration increases above the rate of inflation on South Africa’s precarious fiscal position. The true nature and full impact of this problem was not disclosed for many years.

Despite limited information, concerns were also raised about the growth trends in civil service remuneration and in social grant expenditure, with a concomitant impact on government borrowing and the interest burden, as far back as May 2013. It was only after continued requests that an appendix detailing civil service remuneration trends has begun to be included annually in the government’s Medium Term Budget Policy Statement since 2017.

A major deficiency in South African fiscal policy is promises made by politicians and demands by civil society for more expenditure, that cannot be accommodated within the budget limitations facing the government. One current example is growing demands for a universal basic income grant.

These demands are made with seemingly little acknowledgement of the country’s precarious fiscal position.

Averting the inflation pitfall

Under conditions of fiscal unsustainability, many countries often also suffer high inflation. This danger should be averted in South Africa.

Containing inflation is the responsibility of the South African Reserve Bank in terms of a monetary policy framework anchored in inflation targeting. However, this responsibility has to be supported by sound fiscal policy. Containing inflation can become impossible under conditions of fiscal unsustainability.

Under conditions of high inflation, the real value of government debt is eroded, thus reducing (in real terms) the burden placed on government’s fiscal position. In such a situation the government is the only winner, albeit at the expense of the general population.

But the caveat here is that these are merely short term wins with long term detrimental economic effects far outweighing any short term gains.

Will someone be listening this time?

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