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Why Zuma’s free higher education plan will cripple South Africa’s finances

South Africa’s fee-free higher education initiative, controversially introduced by President Jacob Zuma in the dying weeks of 2017, will plunge the country into a deeper financial crisis if it isn’t adjusted one way or another.

Days after Zuma made his surprise announcement, Ramaphosa was elected president of South Africa’s ruling party, the African National Congress. He is set to become the country’s president when Zuma’s term expires if the ANC wins the country’s 2019 national elections.

It’s now for Zuma’s successor Ramaphosa to do the tricky tampering. He will need to be politically and financially adept to manage this situation. He can’t simply reverse a populist decision and he clearly won’t be able to meet it fully without serious adjustments to the country’s finances.

Zuma’s plan seeks to provide fee-free tertiary education to students from households with a combined annual income of less than R350,000 with immediate effect. Estimations suggest that this covers 90% of students in the higher education system.

This is certainly a noble idea. But Zuma’s rushed unilateral decision ignored all sensible views that it can’t be done in the way he is proposing. Zuma ignored the National Treasury headed by Finance Minister Malusi Gigaba, whom he handpicked. And he disregarded the views of the Heher Commission he appointed to look into the matter, which stated emphatically that South Africa cannot afford fee free education.

The cost of this proposal could be disastrous for a country that’s already burdened by significant debt considering that Zuma’s promise will cost the country between R15 billion and R50 billion per year. At current debt levels, South Africa’s public finances are already highly constrained. The country is struggling to fill the R50.8 billion budget deficit, which is projected to rise to R89.4 billion by 2020. This is approximately -4.75% of GDP, the highest since 2009 and more than the average of -3.26% over the period from 1989 to 2017.

The sovereign debt situation

Since the dawn of democracy, South Africa has become more reliant on sovereign bond issuance to support its budget. South Africa’s sovereign bonds are issued by the government through the South African Reserve Bank primarily to raise funds for large capital projects.

The government’s debt has been rising steadily for the last decade. It reached a record high of R790 billion (51% of GDP) in the second quarter of 2017, up from R726 billion in the first quarter of 2017. It is expected to rise even further, with some estimates suggesting it will shoot up to more than R2 trillion (60% of GDP) by 2020. This is far higher than the average R390 billion from 2002 until 2017.

At this debt level, the government is paying approximately R13 of every R100 (13%) collected in revenue as interest payments to sovereign lenders. This figure is much higher than expenditure in general public services (5.5%), defence and security (4.8%), police services and (6.7%), basic education (7.3%), tertiary education (9.2%), and economic infrastructure (6.8%).

The government debt servicing costs for 2018 are estimated at R183 billion, which is forecasted to rise to R223 billion by 2021. This means government debt repayment is the fastest growing expenditure item of the budget. The implication is that in the next three years the government will be spending more money on repaying its debts than on key service delivery priorities such as social and economic development.

It’s therefore clear that the country can’t afford to add another R15 billion to R50 billion to expenditure.

Available options

Funding for Zuma’s fee-free plan will either have to come from tax hikes (including an increase in the Value Added Tax rate), significant austerity, budget reallocation’s or additional borrowing.

With an economy stuck at sub-optimal growth, facing more rating downgrades, and a significant tax shortfall in the near future, the Ramaphosa administration may face the political inconvenience of having to explain why Zuma’s education announcement has to be retracted, amended, or delayed.

Retracting or delaying the policy aren’t options because either would likely spark civil unrest. But populist policies such as these condone financial indiscipline at the expense of much needed fiscal consolidation. The consequences will be severely damaging to the country’s development for many years.

It is vital that the government tackles the escalating sovereign debt by drawing up a proper implementation strategy. This needs to be in line with austerity measures to allow fiscal consolidation to reduce the widening budget deficit.

It must do this in a way by balancing three things: economic growth, a smaller fiscal deficit and meeting increasing social demands. Instead of trying to raise funding for free higher education the government should rather consider disposing unessential state assets, reducing government debt guarantees to state owned companies, and clamping down on corruption and wasteful expenditure.

Fiscal cliff

If the fiscal situation continues to deteriorate, South Africa risks having its domestic bond ratings downgraded to sub-investment grade by all the three international credit rating agencies. This would be disastrous for the country, which has already been subject to downgrades on its foreign denominated debt.

Moody’s is the only international rating agency that hasn’t downgraded South Africa to “junk status”. If it does so to the country’s sovereign currency rating, the country’s sovereign bonds would be excluded from the Citigroup’s world government bond index. If this happens many foreign asset managers with investment grade mandates would dump the country’s domestic bonds. South Africa’s bond yields will shoot up, further escalating debt servicing costs. Similar circumstances have led countries such as Brazil, Cyprus, and Greece into vicious debt cycles.

Zuma may have lobbed a populist hot potato at the ANC elective conference. But it’s ordinary South Africans whose fingers will be burnt.

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