Africa-Press – South-Africa. South Africa has begun taking the bitter medicine of fiscal consolidation to prevent the country from entering a debt spiral and potential financial crisis.
While the progress is slow, it is concrete, and investors are beginning to take note, as they pump money into local government bonds.
This does not mean the country is out of the woods, with it still facing serious financial trouble in the coming years due to its stagnant economy.
Old Mutual Wealth’s chief investment strategist, Izak Odendaal, outlined South Africa’s dire financial situation and the potential remedy in a recent research note.
South Africa has a severe fiscal problem, with its debt-to-GDP ratio crossing around 75% in the current financial year.
While this is lower than some of its peers and most developed economies, it has more than doubled in the past 15 years. Odendaal said that this is what will concern investors.
Given its much higher borrowing cost, the South African government now spends about a fifth of tax revenues on interest payments, significantly limiting investment in other areas of the economy.
Unlike France, the US or the UK, however, South Africa has started taking the bitter medicine of fiscal consolidation, Odendaal said.
This medicine involves limiting spending increases to in line or below headline inflation to generate a primary surplus, which the government has managed for the past two financial years.
This should limit any increases to the country’s debt burden and enable the state to begin paying it down over time.
A primary budget surplus means that the government is bringing in more money through tax revenue than it is spending, excluding debt-servicing costs.
The last time South Africa’s government ran a full budget surplus, which includes debt-servicing costs, was in the 2007/08 financial year.
Faster growth and lower inflation
Old Mutual Wealth’s Izak Odendaal
The government cannot rely only on fiscal consolidation, with it needing to address the root cause of its financial headache – slow economic growth.
South Africa’s financial crisis is a direct result of slower economic growth, which limits increases in tax revenue and negatively impacts the state’s debt ratio as a share of GDP.
The government is trying to address this through reforms in network industries, particularly logistics and electricity, but progress has been slow.
These reforms should open the sectors up to increased private competition and investment, boosting economic growth, but much work still needs to be done, Odendaal said.
The stronger the economy, the more tax revenues grow organically, reducing the need for the government to borrow to fund its expenditure. It also limits the need for any increases in tax rates.
This growth is crucial as the government currently borrows debt at a higher interest rate than nominal GDP growth.
This gap between interest rates and growth, sometimes expressed by economists as, renders borrowing unsustainable since debt compounds faster than the income needed to service it.
This is at the core of South Africa’s fiscal challenge, as debt-servicing costs are the fastest-growing expenditure item in the budget, with the government spending over R1 billion a day on interest payments.
The Reserve Bank has recently promoted another way of reducing this debt burden through a lower inflation target, which should translate into lower interest rates.
While the National Treasury must still formally shift the inflation target from a 3% to 6% range to 3%, the Reserve Bank has already shifted its focus to the bottom end of the range.
Getting inflation and expectations to stick around 3% will not happen overnight, but if it is done, then interest rates should be reduced over time to ease borrowing costs.
However, this relief will only come in time and may also come with slower economic growth in the short term as rates stay higher to bring inflation down to the lower target.
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