Finance Minister Tito Mboweni tabled some alarming numbers in his Supplementary Budget Speech this week, not least of which is the increase in the consolidated budget deficit to 15.7% of gross domestic product (GDP). In our view, the key takeaway of the Minister’s speech is that the government realises its current fiscal position is untenable, and has promised to implement reforms to lift economic growth and cut spending. We’ll have to wait for the October Medium Term Budget Policy Statement for details, however.
In its response to the COVID-19 pandemic, the government had to show how it would manage the humanitarian crisis (healthcare and hunger), the negative impact on incomes and the effect on financial markets. An essential component of the strategy is to keep businesses open and people employed.
The Treasury’s June 2020 Supplementary Budget aims to do exactly this as part of the government’s R500 billion economic support package announced late in April. Main Budget non-interest spending increases by R36 billion as new spending allocations of R145 billion aimed at easing the impact of the pandemic have been made possible by a R100.9 billion reduction in baseline allocations and other adjustments of R8.1 billion.
In addition, the social security funds are also lending assistance. The Unemployment Insurance Fund, for example, had paid R23 billion to 4.7 million employees by mid-June 2020, reflecting the COVID-19/Temporary Employer/Employee Relief Scheme Benefit.
BUDGET DEFICIT INCREASE
But whereas the government’s response has been sizeable, appropriate and well targeted, there is a problem. Given an expected shortfall of R298.5 billion in Main Budget revenue due to the Treasury’s estimate of a -7.2% fall in real gross domestic product (GDP) in 2020, tax relief measures of R26 billion and a collapse in tax buoyancy in the recessionary environment, the Main Budget deficit increases to an expected R709.7 billion in 2020/21. This amounts to 14.6% of GDP compared to the initial February 2020 estimate of 6.8% of GDP (or R368 billion).
At the same time, the consolidated budget deficit is even larger at R761.7 billion or 15.7% of GDP (mainly due to use of social security funds in the order of R49.1 billion). However, the market must fund the Main Budget balance – including redemptions, the gross borrowing requirement is R776.9 billion.
LIMITED DOMESTIC SAVINGS
This is a large amount of money to finance. The problem is the limited domestic savings pool. In 2019, gross domestic savings amounted to R739.9 billion. Together with foreign savings of R153.2 billion, this funded domestic investment of R893 billion. Even if the domestic savings rate increases (as it typically does in a recession), GDP in current prices is expected to decline by -3.5% in 2020. A limited (if any) increase can therefore be expected in gross domestic savings in absolute terms relative to last year.
Even after taking into account planned foreign funding (R125.2 billion) and use of the government’s cash balances (R43.2 billion), the Treasury aims to fund R146 billion through short-term loans and R462.5 billion through domestic long-term loans. That implies substantial pressure on domestic savings, unless large additional foreign capital inflows materialise this year. This can only be achieved at the expense of a collapse in private sector investment.
The worrying development is the increase in debt service costs from R204.8 billion (4.0% of GDP) in 2019/20 to R236.4 billion in 2020/21 (4.9% of GDP). Apart from crowding out other government expenditure, the real interest rate on government debt is far too high relative to real GDP growth.
ECONOMIC REFORM
Other than the provision of pandemic-related relief programmes, the key takeaway from the Supplementary Budget is that the government realises its fiscal position is untenable, and has promised the pursuit of economic reform.
The Main Budget primary budget balance (revenue less non-interest spending) is expected to improve from a deficit of -9.7% of GDP in 2020/21 to -2.3% of GDP in 2022/23 (as the economy recovers and non-interest expenditure declines to 26.8% of GDP from 32.4% of GDP). However, this is insufficient to prevent the debt ratio from increasing to 97.2% by end-2022/23. Meanwhile, the interest bill increases to 5.4% of GDP (R301.1 billion) over the same period.
Given this scenario, Minister Mboweni announced that the government plans to implement economic reforms that would lift economic growth (and hence government revenue), while cutting spending, so that the primary budget balance returns to a surplus by 2023/24 – sufficient to ensure the debt ratio peaks at 87.4% of GDP at the end of that year.
To put this into perspective, spending reductions and revenue adjustments amounting to around R250 billion are required over the next two years. It’s a bold, ambitious move by the Treasury and it has been endorsed by the Cabinet.
To the extent that the promised adjustments imply tax increases, it is likely to defeat the object of the exercise. And we must wait for the October 2020 Medium Term Budget Policy Statement for details. Meanwhile, this year’s funding problem remains onerous.
