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Budget 2021 From an Outside-In Perspective

South Africa’s Finance Minister, Tito Mboweni, delivered an upbeat budget to parliament on Wednesday.

Surprisingly strong revenues offset some debt woes

The government still expects its budget deficit to more than double in the current 2020/21 fiscal year, to 14% of GDP from 5.7% of GDP in 2019/20. But the new estimate is smaller than the 14.6% GDP deficit that was envisaged in the October supplementary budget. While the prolonged impact of the Covid-19 pandemic on South Africa’s economy means that the government had to revise up its expenditure figures for both this fiscal year and last, higher spending was more than offset by surprisingly strong revenues. Receipts in 2019/20 were 3.5% of GDP higher than anticipated in the October budget and are expected to be about 5% of GDP higher in the current fiscal year.

There was even better news on the medium-term outlook. The government expects to more than halve its budget deficit to 6.3% of GDP with a primary deficit of just 0.8% of GDP by 2023/24. This is anticipated to be enough to stabilise the debt ratio at 88.9% of GDP by 2025/26 before starting to bring it down thereafter. While this is still very high, it is significantly lower than the peak of 95.3% of GDP that was projected just four months ago.

Are the targets reasonable? The verdict is out as to whether the SA government will deliver

In the longer term, the impact of the budget on the performance of financial markets in South Africa will hinge on the government’s ability to deliver on its ambitious targets. The macroeconomic assumptions appear to be reasonable and avoid the usual trap of being too optimistic. Indeed, the government’s projections for GDP growth of 3.3% this year and 2.2% in 2022 are broadly in line with consensus. Expectations for inflation to average about 4% through to 2023 are similarly sensible.

The main question marks come from the fiscal projections themselves. The government has ditched plans to raise taxes to avoid putting undue pressure on the economy as it recovers. This means that revenues are expected to rise by just 1% of GDP by 2023/24. Instead, the government expects to achieve almost all of the fiscal consolidation through an aggressive reduction in expenditure from an expected 41.7% of GDP in the current fiscal year to 34.9% of GDP in 2023/24 – a cut of nearly 7% of GDP. Some of this will of course occur naturally as a re-opening of the economy reduces the need for social transfers.

However, the budget relies on real-term cuts in spending on public sector wages and services in the medium term and efficiency gains from streamlining public sector activities. Efficiency gains are almost never achieved in those emerging markets that rely on them to deliver austerity. And while the government has stood up to growing discontent at restraint on spending in areas such as public sector wages, it will be increasingly difficult to ignore concerns further ahead as the next general election in mid-2024 comes onto the horizon.

What else can the authorities do?

A more sustainable way to improve the public finances would be for the government to press ahead with macroeconomic reforms to raise economic growth by tackling South Africa’s long-standing problems of low national savings and investment rates. A relatively small pool of savings means that there is not much capital available to invest. The low investment rate means that the supply side of the economy struggles to keep pace with demand, leading to structurally high inflation and low real GDP growth. It also means South Africans need to supplement domestic savings with borrowing from abroad to raise investment. Not only does that explain South Africa’s structurally high interest rates but also its tendency to run current account deficits which result in external vulnerabilities and volatility in the rand.

As the chart below shows, South Africa has one of the lowest national savings and investment rates in the emerging world, which is a key reason why it has relatively weak economic growth, high interest rates and volatile currency.

Source: WEF, IMO

The government reiterated its long list of structural reforms to boost economic growth by investment in infrastructure and improving the business environment amongst other things. Reform momentum has understandably stalled during the crisis. It is crucial that the government gets on with the job if there is to be a long-lasting improvement in the economy and public finances that would deliver a sustained period of strong returns from South African assets.

By David Rees, Senior Emerging Markets Economist at Global Asset Manager Schroders