ERSA’s Fiscal Futures Webinar Series - Brief I

In this brief we introduce you to the themes and the participants, and then the first two topics: first Treasury and the South African Reserve Bank’s Response to COVID, and second the fiscal deficit and fiscal sustainability. Brief two covers the discussion around government debt, including a presentation by Treasury. Brief three discusses economic growth, brief four the credibility of South Africa’s financial institutions and complacency risk, and brief five covers the policy reforms which South Africa needs to make.

Introduction

As a contribution to the debate about economic policy making after the COVID shock, Economic Research South Africa (ERSA) presented a series of four conversations about how we think about the economy and the role of fiscal policy.

Fiscal policy is the means by which a government adjusts its spending levels and tax rates to manage a nation's economy. It is the sister strategy to monetary policy through which a central bank manages a nation's money supply. These two policies together direct a country's economic goals.[1]

After the initial shock brought about by COVID and the short-term welfare response from the state, what is the role of the state and fiscal policy in supporting an economic recovery?

In these discussions, local and international economic policy experts presented their views and discussed how to best manage the contribution of fiscal policy to development after the COVID shock.[2]

Once the COVID crisis subsides, we will be faced with a poorer economy, significantly higher government debt and interest costs, as well as spending pressures.

This series of briefs begins with the participants’ general views of the government’s financial response to COVID, followed by comments made around the fiscal deficit and fiscal sustainability.

Treasury and SARB’s Response to COVID

We are in a “war-like” time and the COVID crisis has increased the marginal utility of current government spending because it is directed towards personal-protective-equipment, COVID testing, and so forth. It is therefore optimal to let government debt rise and, if fiscal policy is credible, debt can be paid back in the future with revenue generated from economic growth. What matters more than ever is the correct mix of policies from government.

Some advanced countries have been more aggressive than South Africa with their spending, but their interest rates are close to zero so their debt service expenses are much lower. Furthermore, long-term prospects depend on more than South Africa’s COVID response. The large increase in government debt must be considered along with South Africa’s corporate and household debt, which is currently not as high as in some other countries.

The fiscal deficit and fiscal sustainability

The fiscal deficit is the amount government spends in excess of revenue it receives. Fiscal sustainability refers to government’s ability to fund its expenditures. In practice, fiscal sustainability is measured using a projection of the future, and it is as much an art as a science.

Broadly speaking, there were two camps represented by the speakers. One camp argued that more government spending is required to help lift the South African economy, while the other held that the country is facing a fiscal crisis and government needs to tighten its fiscal belt, which will also help spur economic growth. We will begin with the points made by the former.

Arguments for more government spending

The fiscal crash narrative is incorrect and we are far away from ending up like Zimbabwe or Venezuela. We saw the same panic after the last crisis when interest rates (and perceived risk) on government bonds rose to 12% but fell a few weeks later to 6%. Now we have the same again, with quantitative easing (bond buying by central banks in developed countries to try and support the economy) being even larger this time. We cannot avoid deficits in the medium term and the government should be borrowing by issuing bonds with short-term maturities as these have lower interest rates. Furthermore, interest rates in advanced economies are very low compared to South Africa’s and, given South Africa’s undervalued currency, we will continue to attract foreign investors. Ultimately we have a growth problem and not a fiscal one.

Treasury’s plan for fiscal consolidation aimed at decreasing government spending is politically impossible, given South Africa’s history and the ruling tripartite alliance – between the ANC, Cosatu and the SACP – and is therefore not credible. It is also not credible economically because the time-horizon for fiscal consolidation is economically irresponsible and will do more harm than good. We therefore require a counter-cyclical policy, one that uses increased spending to spur economic growth. A transition to a sustainable growth path is needed without imposing self-defeating fiscal consolidation, which would increase the debt-to-GDP ratio, weaken growth and with it the economy’s ability to generate future tax revenue. The projected deficit for 2020 results mainly from a drop in revenue collection, not spending. The challenge with fiscal policy is finding spending multipliers that work and we must focus intensely on what gets investment going, including at the municipal level.

Arguments for less government spending

The second camp argued that South Africa is facing a fiscal crisis and government needs to tighten its fiscal belt which will also help spur economic growth.

South Africa’s budget deficit is the worst amongst its peers and we are facing an immediate fiscal crisis. In 2020/21 and for the first time ever, the budget deficit will exceed gross national savings. Treasury’s expenditure ceiling keeps increasing and government’s spending levels are more than it can sustain. It is impossible to argue that stimulating economic growth through a temporary increase in government spending will work, because spending has been increasing aggressively since 2008 but with no economic growth to show for it. A financial crisis could emerge quickly.

South Africa’s fiscal policy since the global financial crisis has been to respond to the economy’s output gap (actual versus potential GDP) by spending more and increasing the fiscal deficit. However, government’s increasing expenditure is crowding out private goods and services by increasing debt, which increases risk and interest rates along with it, thereby reducing funds available for investment and for government to deliver on its mandate. So while we are not in default, we are in a fiscal crisis.

There has also been no multiplier growth from this increased spending. A fiscal expenditure decrease is more pro-growth because government releases resources for investment. At the end of the day, increasing fiscal spending increases consumption and decreases investment. Fiscal sustainability is therefore a requirement for broader economic sustainability.

Although government’s budget deficit and debt are rising, the ability to fund expenditure still exists, with a large reliance on foreign investors. Foreign investors, who are important contributor towards not only the fiscus but the whole economy, choose to take the exchange rate risk. But if their view changes the rand will depreciate aggressively as funds flow out of the country.

Lastly, while fiscal crises in emerging markets take longer to emerge than one might think, they develop quickly when they arrive. Therefore, running a deficit has a non-linear effect over time and when crises occur, government does not have financial room to respond to any new contingencies.

Charles Collocott
Researcher
charles.c@hsf.org.za

[1] https://www.investopedia.com/insights/what-is-fiscal-policy/