Converging pressures dictate austerity

01 March 2015 - 02:01 By Azar Jammine
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Before Nhlanhla Nene presented his budget this week, many thought it would be the most daunting for any finance minister since 1994.

Over the past six years, public debt levels have been rising sharply as budget deficits exceeded South Africa's economic growth rate. At the same time, economic growth has languished, so growth in state revenue has undershot expectations.

International ratings agencies have put pressure on the government to keep lowering the deficit, and doing so has come to be seen as essential to sustaining the country's investment grade ratings.

Any downgrade in credit ratings, especially to sub-investment grade, would be disastrous, potentially causing long-term interest rates and the cost of servicing government debt to rocket while crowding out other more vital forms of expenditure.

Nene made it clear that the government had no option but to pursue austerity. This meant he would have to restrict growth in real non-interest government spending to no more than 2% a year over the next three years - a big ask, considering this had been growing at 8%- 14% in much of the preceding decade.

It also meant having to cap growth in the public sector wage bill. The only way to do this is to restrict growth in public servants' wages or trim the size of the public service.

In October last year, Nene intimated that taxes would need to be raised by R12-billion in fiscal 2015-16 as part of a cumulative R44-billion increase in taxes over the next three years. The ratings agencies responded positively: Standard & Poor's and Fitch left their credit ratings and outlooks unchanged in December.

So when Nene made it clear this week that he planned to stick to a programme of deficit reductions, the government clearly believed that the agencies would maintain their investment-grade ratings.

The other factor contributing to the government's decision to stick to fiscal austerity is that rising government debt itself has exacted an ever-higher interest bill, irrespective of developments in regard to credit ratings.

Government expenditure projections show that debt servicing costs are set to rise from 9.3% in 2014-15 to 9.8% in 2017-18. This has forced the Treasury to budget for a decline in the share of compensation of employees, from 35.5% in 2015-16 to 34.5% in 2017-18. As a result of wage restraint, a damaging public service wage strike is a distinct possibility.

But the reality facing the government is that average growth in expenditure on debt servicing costs budgeted over the next three years comes in at 10.1%, far higher than the growth of overall expenditure of 7.9% a year. In contrast, spending on essential social services such as basic education, health and police has had to be curtailed.

The economic situation has deteriorated since the tabling of the medium-term budget policy statement, and the 2015 budget includes downwardly revised growth rates for 2015 and 2016.

As a result, the Treasury has had to plan on increasing its tax collection for the coming year by R5-billion more than the R12-billion suggested in the medium-term statement.

To source this additional revenue, the government has exploited the lower oil price by raising the fuel levy by significantly more than inflation. The big shock was the allocation of a further 50c a litre on the fuel price to increase the funding of the Road Accident Fund. Taking into account the fact that the fuel price is set to rise by around R1 a litre this week after a rebound in oil prices, it is set to rise by at least R1.80 a litre, or about 12% on the current price, by early April. Even so, it will still be some 15% lower than it was a year ago.

It is therefore misleading to suggest that the rise in the fuel levy was uncalled for.

The Treasury took a balanced approach, not loading the fuel levy entirely to generate the tax it needed but instead increasing personal tax rates by one percentage point across most income categories. This is not completely debilitating for the economy.

The budget left one with the notion that there was little to make a major contribution to enhancing sustainable growth.

Cumulative expenditure on infrastructure will amount to R803-billion over the next three years, yet for the past five years this figure has hovered between R800-billion and R850-billion, implying a decline in real terms. This is bound to reduce the sustainable growth rate of the economy in the longer term.

The minister was at pains to assert the government's commitment to the National Development Plan, yet one was left with lingering scepticism regarding the likelihood of its implementation.

Major initiatives such as the National Health Insurance scheme, land reform and pension reform were left somewhat in abeyance, with the intention to debate these with the relevant parties. On the poor performances of state-owned enterprises, there was little that was new to encourage one to believe they will function more effectively.

In sum, there was little in the budget to inspire a belief that economic growth is about to accelerate within the three-year time frame of the budgeting process. Instead, one consoles oneself with the thought that its austerity will help consolidate the notion of a solid institutional framework for the fiscus that should limit the magnitude of the fall in capital investment by foreigners and locals.

The budget is likely to stave off credit rating downgrades in the near term, but will reduce economic growth by virtue of the tax increases.

At the same time, it was not in any way so destructive as to cause a major economic downturn, either. The economy is set to continue "muddling along" at a suboptimal growth rate of around 2%.

Jammine is director and chief economist for Econometrix

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