Shark infested waters

Credit agencies may be appeased but fiscal risk remains high.

The South African government may have done just enough to appease the ratings agencies but in the medium to longer term the fiscal risks remain high.

Finance minister Nhlanhla Nene acknowledged that South Africa is walking a very fine line when it comes to balancing the fiscal demands of the state. However the price of letting the country slip would be high: “Rising debt service costs, which amount to R115 billion in 2014/5, and R153.4 billion in 2017/18 or 3.1% of GDP, threaten the sustainability of social gains achieved over the past decade,” he says.

While expansive fiscal policy has supported the economy for the last seven years, this counter-cyclical approach has reached its limits. South Africa’s budget deficit is largely structural and cannot be reduced through a hoped-for cyclical upturn in revenues.

With this in mind government has introduced some measures to reduce the structural deficit. These include reducing expenditure, capping government’s work-force, increasing spending efficiency and increasing taxes.

This is all a delicate balancing act. In particular any increase in taxes needs to be carefully balanced against the need to encourage and foster entrepreneurial activity in the country.

Nene identified three risks that could push the country off the wire.

The public sector wage bill

Over the past decade public sector labour costs have increased by more than 80% in real terms with an average annual growth rate of more than 6% above inflation. The compensation of employees has contributed in large measure to the structural fiscal deficit. So while government is budgeting for a wage agreement that protects the real buying power of public servants there is a concern that if current negotiations depart significantly from inflation, government will have to effect substantial reductions in capital spending or employment to make up the difference.

Weaker than expected economic growth

South Africa’s economic growth forecast has been revised downwards for the fifth consecutive year from 2.5% to 2% in 2015, gradually increasing to 3% in 2017.

Despite the implementation of a spending ceiling, this weak economic growth has produced a persistently large budget deficit. This means the state is struggling to provide for the social needs of the country’s 50 million people and it is unable to finance the infrastructure necessary to drive economic growth.

The lower oil price (20% of SA’s import bill is spent on oil) and more competitive rand exchange rate will support growth, however the inadequate electricity supply is imposing a serious constraint on output and exports.

Government is scrambling to resolve this issue. It is procuring additional co-generation capacity; it has invited new bids for independent power producers to build coal fired power stations providing up to 2500MW of electricity; and it has released a request for proposals for 3126MW of power from natural gas. It is also actively working to secure gas supplies.

In one scenario outlined by the department of Finance, it estimates that a worsening in the electricity situation could reduce growth to 1% this year.

Another scenario suggests that a decline in global growth (0.5% more than anticipated) could push commodity prices down by an additional 10%. In turn, this could lower GDP growth to 1.5% in 2015 and 2.1% in 2016.

Financing of SOEs

The provision of additional direct fiscal support, equity injections or guarantees to public entities could also prevent the Treasury from reducing the country’s budget deficit as promised.

In the 2014/5 financial year the public sector borrowing requirement is R246.8 billion or 6.4% of GDP. This figure was revised upwards by R16 billion from the last budget as a result of higher than anticipated borrowing needs of state-owned companies.

The state is working on a number of short-term plans to stabilize the finances of the worst affected companies (SAA and Eskom) and create sustainable financial frameworks for them. In the longer term government is looking at ways to “optimise its portfolio of institutions such that they strengthen national development,” and do not increase the budget deficit.

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