The Supplementary Budget is harmful: Alternative financing and time frames are needed

20 Jul 2020

The Supplementary Budget looks to rein in government spending amid the greatest economic downturn South Africa has faced since at least 1930. Cutting spending as an economy is collapsing is like taking a patient off oxygen support when they need it the most.

In a recent article (“Structural reforms — not spending — are the best way to achieve growth”, Business Day, 14 July 2020), Finance Minister Tito Mboweni provides a defence of the 24 June “Supplementary Budget”.

The Budget increases government’s non-interest spending for 2020 by R36-billion, amounting to 0.7% of Q1 2020 GDP (market prices). It then implements sizeable reductions in government spending of about R230-billion in 2021/22 and 2022/23 and beyond. The revenue side of the Budget consisting of debt and taxes is largely neglected.

An alternative approach is to maintain proper government emergency spending during this almost unprecedented crisis, combined with long-term deficit reduction targets phased in over a more appropriate time period. This combination is feasible if the Treasury and the South African Reserve Bank (SARB) work together to reduce new borrowing costs.

The Supplementary Budget instead intends to rein in government spending at exactly the wrong time: amid the greatest economic downturn, South Africa has faced since at least 1930. Cutting spending as an economy is collapsing is like taking a patient off oxygen support when they need it the most. Treasury’s defence is that such life support has its own long-term risks, and in fact may not help.

Evidence shows that targeted emergency government support during an economic crisis can reduce its severity and duration, while also aiding in long-term recovery. The US’s much quicker recovery compared to the European Union (EU) from the 2008 global financial crisis (GFC) is in large part to the timely fiscal and monetary policy measures its government implemented.

Today, central banks and treasuries across the world are applying a far larger emergency fiscal and financial stimulus to offset the damage caused by Covid-19. In normally frugal Germany, this amounts to roughly 15% of GDP. Real-time data indicates that these measures have been effective in providing essential incomes and to some extent in increasing spending.

South Africa is not alone in its present predicament. This means it can learn from others. At the start of 2020, Israel, India, Hungary and Hong Kong all had very similar debt to GDP ratios as South Africa and are all now also expected to see large increases in debt during 2020. Most are trying to reduce the interest burden of new debt, as South Africa should.

Not all spending growth has to immediately increase South Africa’s relative interest burden significantly if concessional multilateral financing and shorter-term debt issuance (at lower borrowing costs) are used, and if the Treasury and SARB agree to more quantitative easing (QE).

Remarkably, South Africa’s borrowing costs at two-year maturities have fallen from 6.69% six months ago to 4.74% today (as of 15 July 2020). And while judiciously used QE for emerging markets is not risk free, so far government bond markets and foreign investors have responded favourably to these existing announcements. As of June 2020, Poland, Croatia and Chile were implementing QE targets of 4%-9.5% of GDP, while South Africa had enacted QE of 0.6% of GDP with a 2% target, according to economist group ING.

Advancing “structural reforms” to improve electricity supply and educational quality, while also vital, are no substitute for the above fiscal and monetary measures. This is because structural reforms target the long-term supply-side of the economy, whereas fiscal and financial measures target the short-run demand-side of the economy.

Once the economy has (hopefully) come out the ICU ward, greater fiscal consolidations can be implemented in the 2022/23 budget. Such a timetable might provide a more realistic starting point to balance the economy’s short-run and long-run needs.

Only the latter can stabilise the fall in incomes and spending which we see at present since they stem from a collapse in demand. Similarly, a critical patient in the ICU ward needs immediate life-saving interventions rather than exercise and a healthy diet. The latter is important, but comes later.

The short run also cannot be ignored since government’s debt obligations are now growing almost entirely because of a collapse in tax revenue (by more than R300-billion) as short-run economic growth collapses, not because of long-run government spending increases. In such an environment further cuts to spending are just as likely to lead to further collapses in tax revenue, as noted in a separate Business Day opinion piece.

Growing interest payments by the South African government on its debt obligations cannot be managed away permanently, though, and must be dealt with over an appropriate time frame – meaning once the patient has come off life support.

The IMF’s chief economist, along with its fiscal affairs director, reiterates this, noting recently (emphasis added):

“While the trajectory of public debt could drift up further in an adverse scenario, an earlier-than-warranted fiscal retrenchment presents an even greater risk of derailing the recovery, with larger future fiscal costs.”

As a result the IMF mostly advises against reducing government spending in the short term during the Covid-19 crisis. Instead, it recommends reducing “wasteful [government] expenditure” as part of a medium-term fiscal consolidation, which include “widening the tax base, minimising tax avoidance and greater progressivity in taxation in some countries”.

An emergency short-term budget could be used in South Africa to provide fiscal and QE injections into the economy during Q3 2020-Q1 2021 of around 5%-10% of GDP each, rather than the present 0.7% of GDP for fiscal measures and 0.6% for QE measures.

Doing so requires more support from the Reserve Bank and far more creativity on the income side of Treasury’s Budget. A medium-term fiscal framework to incorporate greater supply-side reforms and reductions in government largesse, beginning in 2021/22 could follow with a focus on removing wasteful expenditures, rather than reducing the Budget’s non-interest expenditure as a share of GDP, as in the present supplementary budget.

Once the economy has (hopefully) come out the ICU ward, greater fiscal consolidations can be implemented in the 2022/23 budget. Such a timetable might provide a more realistic starting point to balance the economy’s short-run and long-run needs.

Ilan Strauss is a senior research associate at the University of Johannesburg, and lecturers at the Jones Graduate School of Business (Rice University).

Categories:

Tags:

DM is much better if you are signed in...

Business Maverick