The Medium Term Budget Policy Statement: How Credible Is It? - Risk Assessment

This is the second brief in a series of three on the 2021 Medium Term Budget Policy Statement. The first brief considered the baseline projections of the MTBPS. In an uncertain environment, the credibility of the MTBPS depends on its assessment of risks. This brief deals with risks arising from the global economy, institutional failure and social and political conditions. The third brief considers the impact of risk on the functioning of the economy.

The identification and quantitative analysis of risk in the MTBPS

The MTBPS quantifies the following downside risks:

1. Global financial conditions. Global financial conditions may tighten more rapidly than expected, leading to slower global GDP growth, higher interest rates and currency depreciation. This in turn will result in higher inflation and slower growth in South Africa. Tightening financial conditions lead to higher debt-service costs. Under Scenario B in Annexure A of the MTBPS, the debt-to-GDP ratio stabilizes at 79.9 per cent in 2025/26[1], up from 78.1% in the baseline projection. But there is no mention of the assumptions which underpin the quantitative estimate. The effect looks small, but one can’t assess it properly without an indication of the assumed size of the shock.

2. Public sector employee compensation. Annexure B contains interesting quantitative information, but it does not answer the fundamental question: what sort of public wage deal is consistent with the MTBPS projection, and what would happen if the outcome of negotiations is more expensive? The MTPBS points out that the recent wage agreement breached the budget ceiling for compensation of employees by R20.5 billion, and continued deterioration in the financial position of several major state-owned companies. And this agreement was reached when the trade unions were willing to accommodate a relatively low increase in the hope that the case before the Constitutional Court on the implementation of the last wage agreement will go their way, which is itself a substantial risk. 

The mechanism for control is the amounts specified by Parliament for compensation of employees in each Vote, so that what is given in higher wages is taken away in employment. But a lower level of employment has implications for service delivery and it can lead to age distribution problems. Annexure B points out that the work force has already aged as a result of relatively low rates of recruitment in the past ten years, which leads to higher average wages and a drop of average experience down the line when a large number of public servants will retire.

The identification of risks which are not quantified.

3. Forced transfers to collapsing institutions. The institutions chiefly at risk are state-owned enterprises and local governments. Annexure A lists Denel, Eskom, the Road Accident Fund, South African Airways and SANRAL as institutions of concern, but there are more. For instance, Business Day reported on 16 November 2021[2] that the insolvent South African Post Office needs a bailout of eight billion rand. In his speech the Minister said:

In this MTBPS, no additional funding is provided for state-owned companies. The exception to this is where guarantees have been called by creditors and conditions have been met by the SOC in question, within the context of their strategic importance. 

Exactly what the second sentence means is unclear. But there are three reasons why the exception is likely to be invoked. The first is that failure to prevent a default arising from inadequate cash flow may trigger demands for immediate repayment of government guaranteed loans, possibly requiring more money than a bail out would. From an MTEF perspective, the bailout would be the lesser of two evils. The second is that, while a relatively low percentage of government debt is denominated in foreign currency, Figure A.7 in the MTBPS indicates that foreign capital repayments by state owned enterprises will be a substantial proportion of loans which need to be repaid or rolled over in the next few years, so fragile SOCs will face currency risk. The third is that, while long-standing promises to consolidate some of our state-owned entities and let go of those that are no longer considered strategically relevant were repeated by the Minister, when push comes to shove, as it did with SAA, the government cannot bring itself to do it. 

Local government is just as alarming. In a presentation to the National Assembly’s Portfolio Committee on Co-operative Government and Traditional Affairs, the Department revealed that 163 municipalities were in financial distress, 108 had unfunded budgets (even though this is forbidden by the Municipal Finance Management Act), 64 were dysfunctional and 29 were under provincial administration. The baseline projection has responded to this pressure by adjusting the division of revenue. Over the next three years, national expenditure (excluding debt service) contracts by an annual average of 1.8 per cent, provincial resources increase by 0.7 per cent and local government resources increase by 4.1 per cent. But two questions remain open: whether this financial re-orientation will be adequate and, more importantly, whether political supervision and administrative capacity can improve sufficiently to overcome the worst problems of service delivery.

Political risk

4. The MTBPS is not the place to assess political risk, but it cannot be ignored in our assessment. The key risks are:

  • Political inability to take risk-mitigating decisions timeously. Political tensions within the ANC are great and many are visible to everyone. Absence of consensus within it make impossible the taking of some decisions at an appropriate time. Take SANRAL, for instance. Road tolls are unpopular, especially in Gauteng, and difficulties of collection have meant that SANRAL has incurred losses ever since 2014/15, a situation which makes a forced bailout more probable with every passing year. To avoid this, the government either has to maintain its current user pays principle and find a more effective way of enforcing it, or it has to find another way of financing road maintenance and improvement. To date, it has done neither. Equally, the government will find it difficult to take the decision about what, if anything, will succeed the social relief of distress grant after March 2022. Political paralysis can be a source of risk to the MTEF.
  • Inability to hold the MTBPS line on social spending and public sector employee compensation. Here the risks arise from pressures from trade unions, civil society and the public more generally. The MTBPS takes the view – correctly, in our opinion – that fiscal consolidation is necessary for growth to pick up from its current very low level. The modernizing project started in 1994 has crumbled, first slowly and then more rapidly into a welter of patrimonialism, corruption and economic stagnation. To get back to modernization requires negotiation of a valley of transition and the danger is that the government will not have the political resources to do it, especially if bad luck means that we shall be in the valley longer than the three years projected in the MTBPS.
  • Inability of the government to get decisions implemented fast enough by the public service. Three examples will show what is at stake. The MTBPS identifies reform on the treatment of claims arising from medical malpractice in the public health sector as necessary to reducing risk in the provision of health services. It identified reform of the Road Accident Fund to reduce the pressure of claims on its finances. It also recommends the remedying of the disarticulation between the MTEF and public sector wage negotiations. Its proposals are broadly appropriate. But it is not the first time these issues have been raised in budget reviews. The necessary changes should have been made years ago, and they have not.

The next, and final, brief in this series will consider the impact of risks on the efficiency of the economy.

Charles Simkins
Head of Research

[1] MTBPS, Annexure A, p 54

[2] Bekezela Phakathi, SA Post Office faces collapse without bailout, Ministry says, Business Day, 16 November 2021