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A fiscal tightrope

World Bank warns SA to cut spending.

In 2009, in the height of the Global Financial Crisis, former finance minister Pravin Gordhan famously increased government spending in a counter-cyclical bid to stimulate the economy and increase tax collections.

This trend was echoed in other developing countries.

For developing countries the budget surpluses accumulated in the heady years prior to the global financial crisis (GFC) made it possible for them to implement fiscal stimulus during the crisis.

These measures softened the immediate impact of the GFC on the South African economy, but the end result was not as imagined. The economy has not regained its former positive momentum and South Africa, along with many developed and developing peers, now finds herself facing a protracted period of low growth with a depleted war chest.

“Developing economies find that their fiscal space has narrowed considerably and they now face some serious challenges,” according to the World Bank’s Global Economic Prospects report for 2015, released this week.

South Africa has accumulated some R1.2 trillion in national debt since the glory days of 2008. Unless this is reined in, debt will reach 50% of GDP by 2017, up from 23% in 2008.

Debt service costs are rising faster than any other item on the budget and are expected to reach R150 billion by 2017/18, according figures published by National Treasury.

Precisely how Finance Minister Nhlanhla Nene plans to rein in government spending will become apparent when he presents the country’s budget at the end of February.

The World Bank report notes that, faced with weaker export prospects, the looming rise in global interest rates, and fragile financial market sentiment, South Africa and other developing countries need to rebuild fiscal buffers to support economic activity.

This is not surprising news, but it highlights the importance of the upcoming budget. Nene acknowledged that SA’s debt was unsustainable at the mini-budget in October. “Fiscal consolidation can no longer be postponed. Ensuring continued progress towards a better life obliges government to safeguard the public finances by acting within fiscal limits. To do otherwise would risk exposing the country to debt trap, with damaging consequences for development for many years to come.”

One worrying finding from the analysis in the report is that in countries where debt and deficits have widened from pre-crisis levels, each fiscal rand spent on activities designed to boost consumption and national income will have roughly a third less impact than it did in the run-up to the GFC.

The speed at which fiscal space can be restored depends on a host of country-specific factors, including cyclical conditions and constraints on monetary policy. In South Africa the key concern will be that ‘austerity measures’ cannot negatively impact poverty alleviation measures.

South Africa’s fiscal policies have been more successful than most in cutting the rates of poverty and inequality, with tax and social benefits effectively redistributing income from rich to poor.

“Because of fiscal policy, large reductions have been made in poverty and inequality,” World Bank economist Catriona Purfield told reporters in Pretoria late last year. According to the World Bank’s SA Economic Update, the country achieved the largest poverty reductions due to fiscal policies in the World Bank’s sample of 12 middle-income countries. These included Brazil, Costa Rica, Ethiopia, Indonesia, Mexico, Peru and Uruguay.

“Because of social spending like child support and disability grants, old age pensions and free basic services, the poverty rate fell from 46.2% to 39%. That is 3.6 million people who have been lifted above the poverty line thanks to an effective use of fiscal policy,” Purfield said.

However, even with a progressive tax system, inequality in South Africa is still higher than the other 11 countries in the sample. This was because it was one of the most unequal countries in the world.

“Even though South Africa has a very effective use of its fiscal tools, the original problems in income inequality are so high that South Africa is going to need other things to help it address the problem of inequality,” Purfield said.

“To make further progress going forward, you need to complement fiscal policy with higher, more inclusive growth that essentially generates jobs, especially at the lower end of the distribution.”

So while the much discussed windfall brought by lower oil prices offers the Treasury a golden opportunity to improve the country’s fiscal position more quickly than was thought possible before mid-2014, Nene and his colleagues in government will have to pull other rabbits out of the hat.

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