Since the recovery from the effects of covid-19 started up until the end of July this year, the major economic debates centred around Russia’s war in Ukraine and its impact on food and energy prices, all of which folded into the debate about how tight, aggressive and damaging monetary policy is for an economy that is still recovering from the impact of the pandemic.
Diplomatic tensions with the US rose as well, increasing the cost that South Africa pays to borrow from bond markets.
For the large part, South African monetary policymakers have won the war on inflation, thanks to their commitment to the SARB’s constitutional mandate of maintaining price stability in the interest of balanced and sustainable growth. Also, diplomatic tensions seem to be normalising.
The debate has now shifted from monetary policy to fiscal policy, and it is highly ideological and polarised. There are many questions about fiscal policy but this week, I ask three questions to frame the extent of South Africa’s fiscal position.
1) What are the assumptions that underpinned the foundation of the fiscal slippage?
2) What is the consequence of the underperformance of the economy on taxes?
3) What options are available to the government to ensure fiscal sustainability?
So many debates emerged from the covid-19 pandemic about how to revive the economy in an inclusive way. One view was that the pandemic provided an opportunity to build a better economy that would address some of the shortcomings of previous policy choices.
The other view was that the economy was not working for everyone and therefore needed to be fundamentally changed. From a policy perspective, there was a view that policy tools — monetary and fiscal — that were deployed during the pandemic have provided a blueprint of what could be done post the pandemic as normal economic policy.
1) What are the assumptions that underpinned the foundation of fiscal slippage?
When the lockdown measures ended in many countries, demand for goods rose significantly, thus driving commodity prices higher. One of the assumptions was that the rise in commodity prices that ensued with the recovery from the pandemic was a long-term trend and therefore would sustain economic growth for commodity-producing countries such as South Africa. With this assumption in hand and the better-than-expected tax revenue collections to validate the good economic performance, the calls for more social spending became louder and drowned out good fiscal management.
The Social Relief of Distressed (SRD) grant which pays R350 per month to about 8.6 million unemployed adult South Africans at a cost of R36.1bn in FY23/24 was implemented as a temporary measure to alleviate extreme poverty from the covid-19 pandemic. However, it seems reasonable to expect that the SRD is a permanent feature of social spending given that it was extended twice without a permanent revenue source to cover for it. On the two occasions when the SRD was extended, National Treasury officials say they had advised to bring the SRD to an end, but their recommendations were overturned by political leaders.
With the benefit of hindsight, that assumption is not holding up and it now has significant consequences for economic growth as well as fiscal policy choices that need to be made.
2) What is the consequence of the underperformance of the economy on taxes?
Economic growth remains constrained by load-shedding, logistics, low external demand, and tighter monetary policy.
Consequently, tax revenue collections, especially corporate income tax, are underperforming relative to budget expectations. For the first five months of the current fiscal year, tax revenue collections were about R22bn behind budget, which implies a R53bn shortfall for the current fiscal year.
Overspending in the first five months of FY23/24 amounted to R15.3bn (R184bn when annualised), primarily due to higher-than-budgeted salaries and wages. Combined, this implies nearly R240bn worth of fiscal slippage in the current fiscal year.
3) What options are available to the government to ensure fiscal sustainability?
There are three choices that are available to the government: cut spending, raise taxes, or a combination of the two. Given that it is an election year, either choice is undesirable politically, but the cost of not doing any to a desirable extent will be even more costly in the future. It is a choice between the popular vote (in the 2024 national elections) versus fiscal sustainability.
Reducing spending and increasing taxes is not likely to be sufficient to ensure fiscal sustainability. There is a need for a credible growth story, which at this point can only be hoped for from the private sector — provided the government eases the business operating environment. Without this credible growth strategy, any fiscal consolidation that will be shown will remain conditional on the actual implementation of economic reforms.
THIS WEEK’S KEY EVENTS
The Fed and the SARB are scheduled to announce policy rates on Wednesday and Thursday, respectively. Both central banks are expected to keep rates unchanged at current levels — at between 5.25% and 5.50% in the US, and at 8.25% in SA.
That the Fed FOMC will hold rates steady at the September meeting is something that has been well telegraphed previously. What will be key for markets is the tone from Fed Chair Powell on the future path of rates. The market is pricing a 33% probability of a hike in November, supporting the view that the Fed is likely done hiking, particularly if the US labour market continues to cool down.
Likewise, there is less disagreement on this week’s SARB rate decision. Inflation moderated to 4.7% in July, very close to the mid-point, and inflation expectations have declined significantly in the third quarter. Stats SA will release the August CPI and retail sales data on Wednesday. CPI is expected to rise modestly from 4.7% in July to 4.9% y/y in August but to moderate from 0.9% to 0.4% on a month-on-month basis. The inflation print will shape the assessment of the risks to the future rate path of the MPC but not the rate decision itself. The upside risks of inflation are due to the rand’s weakness and strong oil prices. Retail sales are expected to have declined modestly, dropping to -1% y/y in July, from -0.9% in June as the consumer squeeze continues.
China’s prime rate is due on Wednesday. Weak economic activity data out of China signalled some optimism for stimulus following measures taken by the government. However, we expect the prime rate to remain at the current level.
Eurozone and US PMIs will be released on Friday. Market consensus is for both US and eurozone PMIs to remain below the 50 mark, with moderate improvement in the eurozone.
- Isaah Mhlanga, RMB’s Chief Economist and Head of Research
