Mini-Budget 2021 – preview

MTBPS preview: Improved fiscal position should not preclude fiscal consolidation

By Arthur Kamp, chief economist at Sanlam Investments

Finance Minister Godongwana is likely to show a substantially improved fiscal position in the November 2021 Medium Term Budget Policy Statement, relative to previous projections. Indeed, we expect Main Budget revenue to exceed the initial estimate by R130 billion (2% of GDP) in 2021/22, reflecting the positive impact on domestic income from high export commodity prices.

Budget deficit forecast for next two years much improved

There is a material degree of forecast risk, since the fiscal year still has some way to run. But, assuming the one-off cash payment (R20 billion) to government employees in 2021/22 is “deficit neutral”, while including the additional spending announced following the July 2021 protests, we expect a Main Budget deficit of -6,3% of GDP in 2021/22, followed by -5.6% of GDP in 2022/23. This is far better than the projections published by the National Treasury in February 2021, which forecast Main Budget deficits of -9.0% of GDP and -7.4% of GDP for 2021/22 and 2022/23 respectively. A significant part of the improvement in the ratio reflects recent data revisions, though, which revealed that GDP was significantly larger than previously estimated.

A smaller budget deficit implies the government’s gross loan debt ratio should decline, possibly to a shade below 70% of GDP at end March 2022, from 70.7% of GDP at end March 2021. This helps reduce near-term sovereign debt ratings risk, although, looking ahead, higher real per capita income and a clear path towards stabilising (and ultimately lowering the debt ratio) remains imperative.

At the same time, the primary budget balance (revenue less non-interest spending) is expected to improve from a deficit of -1.9% of GDP in 2021/22 to -0.9% of GDP in 2022/23, before switching to a small surplus of 0.3% of GDP in 2023/24. This assumes that the fiscal consolidation path plotted in February 2021 remains intact, except for additional social grant spending, which we have pencilled in at around 0.5% of GDP.

With dismal level of unemployment, social grants need to keep up with inflation

The better than expected fiscal position begs the question as to whether there is room to spend more, given the country’s depression-level unemployment rate of 34%. There is a strong argument that social grants spending should be maintained in real terms, or increased, and it remains to be seen to what extent the Treasury lends support in the years ahead.

However, additional spending on marginalised citizens (over and above maintaining current social grants spending in real terms) requires expenditure cuts elsewhere. South Africa still requires fiscal consolidation. Why? Even though the fiscal position has improved, the government’s financing requirement remains large. Initially, in February 2020, a financing requirement of R545 billion (including redemptions), was projected for 2021/22 – to be funded through gross domestic and foreign debt issuance of R435 billion and use of the government’s cash balances. A revised financing requirement of R450 billion is now expected. Even so, this amounts to 7.4% of estimated GDP. Further, given large government loan redemptions in 2022/23, in addition to the budget deficit projected above, a borrowing requirement including redemptions of R512 billion is expected next year (7.9% of GDP).

Government borrowing is crowding out private sector investment

The flipside of this is development is material crowding out of private sector investment. South African Reserve Bank data shows private sector net capital formation (gross capital formation less consumption of fixed capital) fell R76.3 billion in 2020. This is the first outright fall in a calendar year since the 1980s. Private sector fixed investment has been constrained by electricity shortages and policy uncertainty, but the government’s large borrowing requirement, which has contributed to upward pressure on real interest rates, is a major contributing factor too.

In addition, government spending has been skewed towards consumption at the expense of capital expenditure, so that the associated expenditure multipliers have been weak. This has added to the steady deterioration of South Africa’s potential growth rate.

New debt continues to be issued at high real interest rates

The problem is new debt continues to be issued at higher real interest rates than the current potential growth rate in real GDP. And, although the government debt ratio is expected to be relatively stable in the near term, the expected improvement in the primary budget balance is not sufficient to prevent the government’s debt ratio from continuing to increase over time.

Admittedly, the projected longer-term trajectory of the debt ratio is relatively flat compared with the past decade. But, here’s the thing. Significant fiscal consolidation execution risk lingers. To achieve the projected improvement in the budget balance above, the government’s total expenditure must decrease by around 2.25% of GDP between 2021/22 and 2023/24. This is not easy to achieve, given current demands on the government’s resources. It implies the Treasury needs to stick closely to its intended government wage bill restraint. Meanwhile a lift in potential real GDP growth, sufficient to stabilise the debt ratio, is not guaranteed.

Moreover, the Budget read in February 2021 included provisional allocations to state-owned companies of R21.9 billion and R21.0 billion in 2022/23 and 2023/24. However, additional allocations to state-owned companies , in aggregate, seem likely.

The easy gains might be behind us

In any event, it’s not good enough to merely stabilise the debt ratio. After all, a business cycle downturn is likely at some point. Indeed, the easy gains from the positive terms of trade bounce have probably been made in the current fiscal year, as real GDP growth projections for 2022 reflect a slowdown to around 2% from around 5% in 2021.

In the end, stronger growth, alongside expenditure restraint, is needed to make the fiscal maths add up. The way to achieve this is to lower the government borrowing requirement to create the “space” for private sector borrowing and investment, while continuing with economic reforms to improve the business environment and the ease of doing business.