New fiscal ship needed to avoid icy waters

South Africa’s debt-to-GDP ratio must drop below 60%, meaning some conditions have to be met - and ensuring state-owned enterprises are effective is a priority

Budgets are the single most important signal that a government can send to the market. The prevailing wisdom in international finance is that the optimal sign for governments to send is one of fiscal prudence. In other words, demonstrating discipline regarding government expenditure is an important sign of a commitment to macroeconomic stability. 

This stability is a key drawcard for attracting investment into the country, along with security of tenure — protection of property rights and respect for the rule of law. Without investment, broad-based development remains a pipedream. In South Africa, this is more important than ever, for a few key reasons.

First, net inflows of foreign direct investment (FDI) into South Africa as a percentage of GDP have been exceptionally low since 1998. They have only moved above the 2% mark five times since then, with an anomalous peak of 9.68% (in 2021) despite sound fiscal management of the economy between 1996 and the global financial crisis of 2008. 

The deterioration since then has weighed on investor sentiment, perhaps most vividly displayed in the lack of growth in the critical mining sector. From 2015 (the time of the “weekend finance minister”) to 2017, FDI flows ranged from 0.44% to 0.68% of GDP. Attracting FDI is about sending the right signals and ensuring that those signals are substantiated with credible commitment to honouring investment contracts, providing genuinely secure property rights, and investing appropriately into growth-enhancing infrastructure — human and physical capital.

Second, South Africa’s GDP per capita growth peaked at 4.59% a year in 2006 (from a base of -0.74 in 1998). It plummeted to an all-time low in 2020 of -7.11%, which is attributed to extensive economic lockdown measures during Covid-19. Growth recovered somewhat to 3.66% in 2021, before falling again to 1.06% in 2022. 

GDP per capita growth is an important, if imperfect, metric to measure a country’s progress. GDP growth is relatively meaningless; if population growth outpaces it, the net effect is negative. Projected growth by the treasury for 2024 is only 1.3%, moving up to 1.8% by 2026, which Investec views as overly optimistic. 

South Africa has essentially suffered a pandemic of sclerotic (and jobless) growth as mechanisation increasingly substitutes for labour, and growth is seen in either non-productive (government) sectors or capital-intensive (non-labour-absorptive) sectors. Without investment into labour-absorbing sectors, the economy will continue to stagnate, which has demonstrable negative socio-political effects such as voting for populist leaders.

Third, South Africa’s debt-to-GDP ratio is worryingly high. It climbed from 52.65% in 2015 to 77.38% in 2020. This raises debt-servicing costs, which is especially difficult if that debt is denominated in hard currency. Since 2015, the rand has depreciated significantly — thanks to Transnet and Eskom failures, and rampant increases in organised crime (and a lack of ability to prevent terrorism financing, hence our greylisting by the Financial Action Task Force in 2022). The result has been successive rating agency downgrades, which further erodes the value of the currency. 

For the 2024-25 financial year, the debt-servicing allocation is R382.2 billion (16.1% of the total). This is still higher than any other line item in the entire budget (but lower than it would have been if access to the Gold and Foreign Exchange Contingency Reserve Account or the GFECRA had not been granted). Either way, when debt-servicing costs escalate as a proportion of the budget, it leaves relatively little for welfare (R387 billion if you combine “social security” and “social protection”), basic education (R324.5 billion), health (R271.9 billion) and investment into critical infrastructure (R22.2 billion) that would attract investment, and other key expenditure areas. 

Gross fixed capital formation (GFCF), which “includes land improvements, plant, machinery and equipment purchases; and the construction of roads, railways, and the like, including schools, offices, hospitals, private residential dwellings, and commercial and industrial buildings”, peaked at 21.8% of GDP in 2008 from a base of 16.51% in 1998. It had declined to 14.21% by 2022. For every year since 1998, South Africa’s gross fixed capital formation has been lower than the average for the whole of sub-Saharan Africa, and Southern and East Africa respectively. The treasury predicts that GFCF will grow by a mere 3.7% in 2024.  

This context, combined with a narrowing tax base and a likely shortfall against targeted revenue collection, makes the 2024 budget speech all important. By all accounts, Finance Minister Enoch Godongwana’s pronouncements were met with the sense that “amid significant economic challenges”, the budget was “better-than-expected”. The treasury got lucky in its one-off ability to tap into a R150 billion GFECRA to compensate for some of the shortfall and, cleverly, “reduce borrowings and borrowing costs”. 

As Ryk van Niekerk of Moneyweb put it: “It is unfortunate that treasury had to dip into the fund, as the fiscal hole the government finds itself in is mainly its own doing. Poorly run state-owned enterprises [SOEs], corruption and an increasing unemployment rate due to poor policies and inefficient government departments have cost South Africa dearly.” 

There is some sense of optimism if reforms at Eskom and Transnet bear fruit. But these will be undermined if the government is not able to stick to the proposed budget — civil service wage increases and SOE bailouts have a nasty habit of scuppering budget forecasts, for instance.   

Overall, the treasury and the South African Revenue Service have done an admirable job in a difficult context. Their fellow government departments now need to come to the party. 

The bottom line is that we need our debt-to-GDP ratio to move below 60% again — our economy is nowhere near large or dynamic enough to sustain anything beyond that, and we won’t have access to the GFECRA again. Certainly, the Reserve Bank should not open its vaults again. To run down the ratio, GDP has to grow meaningfully, driven by export revenue and underpinned by FDI that generates employment for unskilled and semi-skilled labour. For this to materialise, some conditions have to be met. 

The treasury can signal fiscal discipline all it likes, but constant bailouts to failing SOEs undermine the power of the signal. Investors will be keeping a close eye, for instance, on the R47 billion guarantee granted to Transnet. It must produce the necessary turnaround in performance, or it will simply be seen by investors as money down a black hole. As witnessed over the past three years, the importance of efficient port and rail logistics (especially for the mining sector) cannot be overstated. 

If the government can seriously sort this out, in partnership with the private sector, and bring load-shedding to a credible end by 2025, net fixed capital formation growth should start to bite. This will take the fiscal ship out of its current icy waters. 

Ross Harvey is the director of research and programmes at Good Governance Africa.