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South Africa’s evil twins

The twin deficits – an impediment to growth in 2019.

An economy simultaneously running a fiscal deficit and a current account deficit is said to have a ‘twin deficit’ – and it often spells a grim economic outlook. A few economies, such as those of Germany and Saudi Arabia, are currently running a ‘twin surplus’ , but the perils of the twin deficit have almost brought countries like Greece and Portugal to their knees.

South Africa’s fiscal deficit is widening. The country’s latest International Monetary Fund article IV review stated that: “The FY17/18 consolidated fiscal deficit is estimated to have expanded to 4.8% of GDP from 4% of GDP in FY16/17.” The widening can no doubt be attributed to inefficiencies within state-owned enterprises (SOEs), which ultimately increase the cost of key production inputs.

South Africa’s public debt versus fiscal strength

As the fiscal deficit is the total debt created by a government to finance its expenses, less revenues, it is a clear indicator that the economy is reliant on borrowing. South Africa’s growing reliance on borrowing is evidenced by its public debt expanding from 27% of GDP in FY2007/8 to 53% in FY 2017/18.

Some economists argue that debt is not bad as long as it is sustainable. The caveat however is that when the fiscal deficit is high, it infers that a government has to borrow more, and this leads to a surge in demand for loans – triggering higher interest rates and, ultimately, higher debt-servicing costs.

According to the IMF, South Africa’s SOEs receive government funds equivalent to more than 1% of GDP annually in the form of direct transfers, subsidies, and recapitalisations. Worse, government guarantees for the ‘ever growing’ SOE debt represent 56% of all contingent liabilities, equivalent to 9% of GDP.

It might be a new year but this twin is only growing bigger.

The second evil twin is the current account deficit – which is basically a measure of a country’s trade, where the value of the goods and services it imports exceeds the value of the goods and services it exports. Figures show that South Africa’s current account deficit widened to R176.6 billion in the third quarter of 2018, which, expressed as a percentage of GDP, registers at -3.5%.

Source: South African Reserve Bank, Investec

“The shortfall on the services, primary income and current transfer account diminished moderately to R190.6 billion in Q3/2018, from R205.7 billion in the previous quarter,” says Lara Hodes, an economist at Investec. “This was principally as a result of a narrowing of the primary income and net current transfer deficits, as the deficit on the trade-in-services segment widened further.”

The twin deficit hypothesis states that a large budget deficit is correlated to a large current account deficit, as is the case for South Africa.

The latest outlook for sub-Saharan Africa from Moody’s reveals how South Africa compares to its peers on the twin-deficits front, and the risk this might pose to recovery in the near term. The outlook is not promising.

Twin deficits have in the past distorted European economies’ fiscal stances, with Greece being a notable casualty. “Greece makes a good study given their heavy fiscal deficit, which pushed the government to borrow from [the] bond market and, given the high, foreign investors rushed to buy,” explains Dumi Jere, CEO of AfriCatalysts. “This led to an increase in demand for the domestic currency in foreign markets, triggering a local currency appreciation that made exports expensive and imports cheaper – so, by default, imports outmatched exports leading to a higher trade deficit.”

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Excellent article. Addresses the big picture where we are going.

It is a good article but a comment is that SA’s debt is not being incurred in the building of productive projects that would improve the country’s ability to service its debt. The borrowed money is more and more being spent on grants to ANC voters and bloated numbers of ANC cadre salaries (increases). Then is the SOE debt included in the 53% of GDP? If it isn’t, the number might be 60% or more – real bailout territory. Hence the hungry circling of ANC jackals around pension funds.

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