South Africa must mitigate both high debt and low growth risks

Globally, despite considerable easing in global inflation over the past year, the stickiness in core inflation has slowed the path to the 2% to 3% inflation targets that many central banks are trying to achieve. Global interest rates remain high, with many emerging economies continuing to experience currency volatility and, often, higher-than-desired inflation. 

Some economies, especially in Latin America, which moved faster to tame the post-pandemic inflation surge, have been able to cut rates significantly more than other economies. Here at home, headline inflation has fluctuated between 5% and 6% over the past six months and is forecast to moderate over the course of 2024, averaging 5.1% for the year as food and fuel price inflation ease. Its return to the midpoint of the target band is only expected in the last quarter of 2025. 

The Reserve Bank notes that South Africa’s GDP growth remains low, mainly due to inadequate energy supply, sharply deteriorated logistics capacity as well as low confidence among businesses and households. GDP growth slumped to 0.6% in 2023, down from 1.9% in 2022 and 4.7% in 2021. The near- and medium-term outlook is for growth to increase, albeit slowly, as electricity supply improves gradually, underpinned by the ongoing private investment in renewable energy generation and increased planned and preventative maintenance by Eskom. 

Household consumption spending is also expected to strengthen as inflation eases, wages rise, pension savings get spent and job creation picks up with investment helping to lift growth over the medium term. Real GDP is projected to improve to 1.2% in 2024 and to rise to 1.6% by 2026.

Importantly, even if achieved, these growth rates remain well below South Africa’s long-term average growth rate of about 2.0% and far below the 4.1% average growth for emerging markets in the current year projected by the International Monetary Fund (IMF).

South Africa has both a rapidly rising sovereign debt and near-zero GDP growth compounded by the limited fiscal space to deal with both! Structural factors are constraining economic growth and the tax base is hardly expanding. The rand exchange rate and increasing dependence on the issuance of short-term and/or foreign currency debt is signalling increasing market nerves about the fiscal outlook. Simultaneously, the country’s tax burden is already heavy and if tax rates were to go up further, private spending and consequently GDP growth would be severely impacted. 

The selling of state assets to boost non-tax revenue is not government policy, while additional tax revenue brought about by improved measures to boost tax collection is drastically waning. Simultaneously, years of government spending that has ordinarily outpaced tax revenue has given rise to a negative spending mix which has favoured consumption over investment. Strikingly, debt servicing costs, the wage bill and social protection spending combined absorb about 70% of tax revenue – all too politically sensitive to cut back. 

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Further limiting any attempt at fiscal restraint is the fact that opex budgets are already tight, capex is at multiyear lows, insufficient checks and balances make misspending rampant, and interest payments (consuming about 20% of tax revenue) continue to soar. What makes this already dire situation worse is the critical importance of Transnet and its poor financial state, where a conditional bailout was inevitable. The factors limiting tax revenue alongside the obstacles hampering much-needed fiscal restraint make the odds of the government running multiyear primary budget surpluses seem low. In fact, the opposite scenario seems more plausible.

Dictated by debt sustainability formulas, this leaves National Treasury (NT) with no alternative but to focus its efforts on reducing the borrowing rate below GDP growth to stabilise the sovereign debt-to-GDP ratio. This process is already under way, but success is not guaranteed. Long-duration debt has always been considered a credit positive for South Africa, so significantly further shortening the average term-to-maturity of the sovereign debt portfolio (domestic and foreign currency) has its limits. 

While NT now being able to tap into unrealised GFECRA profits could be considered a positive, it’s doubtful this development on its own would be sufficient to durably lower the fiscal risk premium embedded in long bond yields. Importantly, the optionality that now comes with access to GFECRA has not resolved the root causes of South Africa’s fiscal problems. To the extent that NT is planning to design a fiscal rule to help reassure investors of its commitment to restoring the health of public finances, important conditions, among others, must be met, it must be flexible enough to allow NT to respond to shocks but with clear mechanisms to correct for noncompliance; an independent fiscal council must be established to enhance checks and balances and the rule must be binding and enforceable. Provided that such conditions are agreed to, a fiscal rule would go some way towards strengthening credibility. 

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Also helpful would be the adoption of a lower inflation target, which seemingly has NT’s support. Bringing about a likely improvement in fiscal and monetary policy coordination could make a noticeable contribution to ultimately limiting rand depreciation, managing inflation expectations even lower and over time reducing borrowing costs across the spectrum of the yield curve. 

Even so, getting both policy changes across the line and agreed to by all social partners would be no easy feat and would take time. There is no doubt that South Africa is facing possible debt distress in the future and addressing fiscal risks in a low growth environment increases the risks of hard financial repression measures – which has implications for the economy as they force economic role players to restructure their balance sheets. DM