Two views of South Africa’s unavoidable financial crisis.

Martin

Source: Biz News

11th September 2023 by Editor BizNews

Magnus Heystek says that South Africa is hurtling toward an economic disaster, with warnings repeatedly falling on deaf ears. The energy crisis, marked by crippling load shedding, exemplifies the government’s disregard for critical infrastructure. The nation’s debt has skyrocketed to a staggering R5 trillion, and the economic growth needed to offset it has faltered due to reliance on the commodity cycle and a downturn in Chinese demand. Experts, from Dawie Roodt to the Fiscal Cliff Study Group, have sounded the alarm, joined now by Afriforum and Sakeliga. As the country edges closer to a full-blown debt crisis, investors are advised to diversify into dollar-based assets to weather the impending storm.

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SLEEPWALKING TOWARDS A FISCAL CLIFF: Will the Govt listen this time around?

By Magnus Heystek

For many years energy experts tried to warn the ANC government that it was heading towards an energy crisis, thanks mainly due to the under-investment in new generating power stations as well lack of maintenance, fraud, corruption and just plain theft at ESKOM. Govt. did not listen.

Consequently, load shedding is now the order of the day with power-interruptions for up to six hours a day costing industry and consumers billions of rands and is a massive drag on our GDP growth.

One can say almost the same with the collapse of Transnet, our roads and municipal infrastructure. Govt has been warned, time and time again, that SA is heading towards an economic disaster and that urgent intervention is needed. There is very little evidence that govt is taking any notice.

Another crisis has been brewing under the surface for an equally long time: SA’s debt crisis has been slowly but inexorably rising from a paltry debt of R500bn in 2006 to a mind-boggling R5 trillion today. Govt finances are in a shambles and it is borrowing billions of rands every month just to repay previous loans and interest.

By itself this does not mean much but it does when the forecast economic growth—and the concomitant tax revenues that goes along with that—have also collapsed, as a result of over-reliance on the commodity cycle and a surprising economic slowdown in China, SA’s largest trading partner.

SA’s economy is sensitive to changes in commodity demand—especially iron ore, manganese, diamonds and gold. It benefitted massively from commodity windfalls in 2004 to 2008 and also in 2021 and 2022. But this year demand from China has fallen dramatically, impacting SA export, company profits and hence taxable earnings.

Govt. has, again—like previous ones– relied too heavily on an extended commodity cycle. Windfall profits were seen as permanent.

WARNINGS GALORE

For many years certain economists and interested parties have tried to warn govt that it is on an unsustainable path, such as Dawie Roodt from the Efficient Group as well as Prof. Jannie Rossouw and his colleagues at the Fiscal Cliff Study Group (FCSG)..

They have now been joined by Afriforum and Sakeliga,  with both organisations now becoming bolder in their warnings about SA’s trajectory towards a debt crisis and soon thereafter a failed state.

Two Sunday’s ago the Sunday Time woke early rising South Africans from their peaceful dreams with a “SA IS BROKE” headline on the front page.

This was followed a week later by another front page scoop, about the—apparently urgent—meeting of the cabinet and members of Treasury at the Spier Wine Estate—to discuss the potential fall-out from a fiscus rapidly running out of money. What makes it even worse, is that this happening just ahead of a general election in 2024, a time when govt-in power loves to open the spending tap.

This time around, there simply is no money, even though the ANC-led govt still keeps on talking about a Basic Income Grant as well as the introduction of the National Health Insurance (NHI).  Quite simply, there is now money for this, but such a triviality has never stopped the ANC from making extravagant promises (think bullet trains and smart cities etc.

It’s time, therefore, in my view, that investors start taking note of what is happening with SA’s spiralling debt crisis. If left unchecked or ignored by govt, could we move towards a full-blown debt crisis within the next 3-5 years with devastating consequences for economic growth, interest rates and subsequently inflation and the exchange rate.

Read more: Dump the junk – Magnus Heystek debunks the Big Mac Index

FISCAL CLIFF OR FISCAL SWAMP?

It’s still early to be talking about a debt crisis—or fiscal cliff—as it has become known in general terms, but if current trends are not reversed, such a scenario WILL happen, says prof Jannie Rossouw, from the Fiscal Cliff Study Group. He is also connected to the Wits Business School.

“It’s a pity we called it a fiscal cliff as it rather becomes a fiscal swamp with government lending money to repay interest on previous loans, wages and salaries with no money left to spend on infrastructure.

The end-result is a default on foreign debt and an approach to the International Monetary (IMF) for more loans to come to government’s rescue,” he said by phone from London where he was attending a conference.

The IMF was in town the other day in Cape Town. Gita Gopinath, 2nd in command and formerly its chief economist, warned openly that that the interest owed on SA government debt could increase exponentially, placing the country in a debt spiral.

The IMF projects that the interest bill on government deb could spiral to triple the size of its health budget in 5 years. This would result in interest payment on debt consuming 27% of the country’s entire budget, up from current 19%.

She said the government must take a two-pronged approach to reducing its deficit- cutting govt. spending and implementing structural reforms.

It also added that it doesn’t see improved economic growth coming to the rescue. Growth this year will be 0,3% and only 1,4 % pr annum  in the medium term.

CURRENCY COLLAPSE IN THE CARDS

International experience shows that country’s who do go into a full-blown debt crisis lose 75% of its currency value in the first year after such an event and then another 25% on average in the following year.

Two weeks ago National Treasury revealed that SA recorded its largest budget deficit since at least 2004, sending the rand crashing and lowering the demand for govt. bonds. In July the budget deficit was R143,8billion compared to a surplus of R36,7 billion the month before.

National Treasury is reportedly proposing a host of extreme measures to get national departments and other spheres of government to cut spending as the country’s coffers have run dry.

Treasury data this week showed that the budget moved to a deficit of R143.8 billion for July, the largest since at least 2004 and wider than the R115.5 billion forecast by economists.

Economists are also sounding the alarm on the full-year outlook, with South Africa’s fiscal deficit for this year expected to exceed the budget set by Finance Minister Enoch Godongwana by some margin.South Africa’s fiscal deficit for 2023 is set to be between 6% and 6.5% of gross domestic product (GDP) -much higher than the minister’s expected 4%.In the budget, Finance Minister Enoch Godongwana said the government wants to stabilise South Africa’s debt level at 70% of GDP, but it has already increased to 72%.As a result, South Africa’s debt situation has also worsened significantly, moving from a relatively modest R500 billion in 2006 to over R4.7 trillion in 2022. This is expected to hit R6 trillion by 2025, putting the country in a significant debt trap.

Similar warnings have emanated from the South African Reserve Bank, which raised red flags over the country’s debt situation. Godongwana is acutely aware of the fiscal problems the country faces, and in a draft document looking for solutions, is proposing huge cuts to spending, a moratorium on advertising new hires and forcing departments to find other means to fund wage increases.

The austerity measures would mark the first time since 2013 that the National Treasury took an official stance, and this is particularly notable as this would come ahead of a national election.

The document reportedly points to much lower-than-expected tax revenues as well, which exacerbates the funding crunch.

It was also reportedly recommended that the provinces introduce similar measures.

South Africa’s provincial governments and municipalities are in deep financial crises – with major metros having already run out of money and many others nearing collapse.

The City of Tshwane has run head-on into a battle with its municipal workers of wages, with the threat of being placed into administration now looming over its head.

Other metros, like the City of Joburg and the City of Ekurhuleni, are struggling to replace parts and do repairs to city infrastructure, with the latter announcing this week that it would have to stop the repair of traffic lights and instead replace them with stop signs as repair funds have run out.

Municipalities’ financial stresses are well known, with one of the most obvious markers being how indebted they are to power utility Eskom, where money owed has rocketed to R64 billion.

Read more: Heystek: NDR and your savings – what planet do SA fund managers live on?

Failed state warning for South Africa

Business interest group Sakeliga says South Africa’s latest round of data shows that the country is in deep financial distress – a situation that is almost always followed by state failure, Businesstech wrote last week.

Government finances have deteriorated sharply in 2023 as tax receipts have fallen further behind the pace of spending.

“Government borrowing has now swelled to around R100 billion per quarter, from an already-imprudent R50 billion per quarter just a year ago,” the group said.

Sakeliga last week –in a special report–noted that the government has run up so much debt since 2008 that interest payments to service its overall debt have spiralled up to nearly R100 billion per quarter as well.

“In other words, almost all government borrowing currently is being used to cover interest obligations from previous borrowing. Not a healthy place to be,” it said.

Meanwhile, other state and government entities such as large state-owned enterprises and municipalities have since 2008 racked up hundreds of billions in new debts, with a rising expectation that these debts will be guaranteed or bailed out by the national government.

Therefore, actual and probable liabilities of the national government have soared in the past 15 years while infrastructure investment has been either neglected or wasteful, and economic value added has stagnated.

“The result is that South African government bonds are less trustworthy than they once were. Lenders require higher interest rates as compensation for taking the (rising) risk of lending to the South African government,” it said.

Failed state

According to Russell Lamberti, the executive director for research at Sakeliga, a deteriorating financial position brings forward immense risks, including pressure on the rand and banking system, desperate politicians pushing for short-term wins to maintain power, and ultimately failure of the state.

“Fiscal distress almost always goes hand in hand with accelerating state failure,” he said.

“While we see state failure as an opportunity to build a healthier and more independent business environment, swift failure in key areas exposes businesses and communities to a rapid onset of more crime and violence, infrastructure decay, and administrative collapse.”

South Africa’s fiscal problem is not a tax problem, he said; it’s a spending problem.

“South Africa is a high-tax country with a comparatively high rate of tax compliance by global comparison. Tax receipts are a higher percentage of GDP today than at any time in the previous 45 years for which we have data.”

Adjusting for inflation, tax receipts are higher in 2023 than they were before the Covid-19 lockdowns, and around 50% higher than in 2008.

“This is not a tax problem. What is evidently lacking is spending restraint and responsible fiscal management,” he said.

Read more: Heystek: What needs to happen for me to change my mind about investing in SA

Weaker rand, tax hikes and more corruption

The government’s “persistent inability” to cut spending and address chronic waste in procurement signals the other risks.

Although short- and medium-term fluctuations in the exchange rate are hard to predict, fiscal stress portends a less resilient and more volatile currency, which harms business and investment conditions, Lamberti said.

“Fiscal risks are also a direct threat to the stability of the local banking system, not only because government is a major employer and spender in the economic system, but more directly because government bonds are a major asset holding of banks.

“A bond market crisis, as occurred during the 2020 lockdown, leads to a banking crisis and commercial credit crunch.”

On policy risks, the director said that diminishing tax receipts and public resources lead to governments seeking desperately to escalate policies that would extract resources from productive sectors of society.

“This can include tax hikes, printing money, and regulatory devices to extract levies, fees, fines, patronage and control for government officials, including asset grabs like special wealth taxes and land expropriation,” he said.

Finance minister Enoch Godongwana has already alluded to possible tax hikes coming to help South Africa pull out of its financial crisis.

“We should expect enhanced efforts by the government to escalate BEE, raise taxes and close loopholes, tighten rather than loosen exchange and capital controls, add regulations to scoop fees and levies, and escalate corruption,” Lamberti said.

TAX THE WEALTHY MORE

But cutting spending is not the way to go, said the Institute for Economic Justice, over the weekend.

In a report written by Gilaad Isaacs, Zimbali Mncube and Liso Mdutyana, it said govt should rather raise taxes on the rich to cover any shortfalls

“The government should cut tax breaks that only benefit higher income earners and the wealthy. The removal of subsidies for retirement provisions could raise R97 billion. Removing the medical credit for those earning above R500 000 per annum could add an additional tax of R6,4bn. The under-taxation of wealth in SA cannot continue—offering large untapped revenue-raising potential.”

WHAT SHOULD INVESTORS DO?

I know I sound like a stuck record, but investors need to urgently get more dollar -based investments in their portfolios. This can be done via asset swaps (the easiest), the R1m Single Discretionary Allowance and the R10m offshore investment allowance. In a full blown debt crisis will these dollar-based investments be invaluable.

Source: Daily Friend

The state has run out of money: Muddle or Reform?

OPINIONS

The National Treasury knows that South Africa is heading into an economic crisis, but it can’t do much about that. It lacks the political authority to raise taxes and reduce spending by the amounts needed to restore longer-term confidence. And an election is less than six months away.

“During an election, nobody wants to increase taxes, but everybody wants to increase expenditure to buy votes. You can’t have both,” said Finance Minister Enoch Godongwana at the News24 2023 On The Record Summit last week.

Our budget deficit and government debt are way above what is manageable, leaving borrowing by the government vulnerable to a market freeze as investors dump bonds. An exchange rate, and possibly even a banking, crisis would almost certainly follow.

Debt service is fast growing and pushing up borrowing costs as well as cutting into state spending on health, education, and capital investment. Foreign investors might like the yields they are getting on our debt, but at some stage their tolerance for the country’s risk will break.

The commodity boom over the past two years considerably boosted the Treasury’s coffers. But now with the possibility that global interest rates might remain high for longer and that the global slowdown could be prolonged, there is added pressure.

Ultimate arbiter

The bond market will be the ultimate arbiter of any attempt by the Treasury to stabilise the situation. In its Financial Stability Report that was released in June, the Reserve Bank pointed to foreigners being net sellers of South African government bonds since 2019 as “a significant structural shift” especially in view of large borrowing by the state. That, it said, raised concerns about the capacity of local investors to continue absorbing new government bond issues.

The Treasury must come up with a solution by 1 November when the Minister is due to present the Medium-Term Budget Policy Statement, which covers the next three fiscal years. This is against a backdrop of tax receipts which are down over R22 billion rand over the fiscal year so far partly due to lower commodity prices, the Eskom crisis, and problems with Transnet rail lines and the ports. Some economists expect the drop in revenue and higher expenditure over what was expected could result in a R90 billion funding gap this year – that is about five percent of what was budgeted. The longer-term worry is that the already narrow tax base is eroding as many skilled high earners leave the country.

With the election looming, there might be few peripheral cuts that impinge little on vested interests, a small tax rise, and more borrowing to cover the gap. But it is unlikely to be sufficient, and even when the election is out of the way the government is unlikely to be decisive.

A bit of luck from slightly higher second quarter growth might slightly ease the predicament, but there is nothing that could fundamentally change the dire situation.

Diminishing buffers

We have diminishing buffers against a crisis. With the drop off in commodity prices and the problems at ports, South Africa has a widening current account balance of payment deficit – more than two percent in the second quarter is a point of vulnerability. But a large stock of foreign exchange reserves helps give foreign holders some assurance that they can get out when they need to do so.

If the state tries to borrow its way out it will have to pay higher interest rates, adding to the already dangerously high debt burden and budget deficit. It cannot achieve big cuts or raise VAT on the eve of the election, as that could punish the ANC at the polls. Increasing VAT by about two percentage points might help finance the continuation of the Social Relief of Distress grant that was brought in to temporarily alleviate hardship around the Covid-related lockdown.

The reforms to boost the economy, like privatisation of public enterprises to stop bailouts and reducing obstacles to investment like empowerment targets and burdensome labour laws, are not on the agenda. These would give investment and productivity a boost and with that could bring about a rise in tax revenue.

South Africa fiscal indicators are in dangerous territory and worse than many other emerging markets. Government debt is about 70 percent of GDP, and with slow economic growth and increased borrowing is due to rise further. The emerging market average of public debt to GDP was 67 percent last year, well above the 60 percent of GDP that is regarded as far safer ground, unless a country is a fast-growing dynamic exporter. Our fiscal deficit could be around five percent of GDP this year, compared to the under three percent the International Monetary Fund (IMF) likes to see.

Big decisions

Dodging the big decisions because it is election time could tip us into a crisis, particularly if there is a global economic shudder like a banking crisis or a spate of emerging markets running into problems. Crises tend to be contagious as markets take shelter in less risky assets when a domino falls.

If a crisis hits, South Africa may not have to rush to the IMF for a bailout, as it could draw on foreign reserves to at least try and stabilise the bond market. In most countries an unsustainable fiscal crisis is combined with a foreign exchange crisis. Our main problem is a budget deficit that we might not be able to finance, and not a shortage of foreign exchange. But if foreigners do not buy our bonds, there could be pressure on the foreign exchange reserves. Eventually we might have to go to the Fund.

That is what the ANC is very scared about, as the Fund is almost certain to insist that empowerment policies end, and that there are no more bailouts to state-owned enterprises. It would undo decades of rule by and for the cadres.

Best is reform before a crisis, but more likely would be a push from a crisis. The ANC is likely to let the crisis go to waste. Muddle rather reform is more likely. The ANC is likely to say yes to a limited range of cuts and reforms and then stop short when it thinks things are sustainable enough. So, we would still be open to crises – like Argentina and a host of other countries.

Crisis-driven reform

Second best would probably be sudden and wide-ranging crisis-driven reform. Unless this is after an election, when a mandate can be claimed or the economy is in a strong upswing, it is very rarely a good time to hurt your supporters. The country’s political leadership would have to come up with a story about having run out of options and a path of reform promising a better future. That is what India did in 1991.

India had almost run out of foreign exchange, the government was about to default, and the IMF suspended its loan. As a condition for a World Bank-IMF bailout, the economy was opened to foreign participation. Soon afterwards a new Prime Minister, Narasimha Rao, took over and undid decades of red tape, paving the way for India’s rapid growth. It was thought to be impossible.

Let us dream on.