South Africa’s deteriorating financial position, particularly its regular budget deficits, threatens to drive inflation higher and force the Reserve Bank to keep interest rates higher for longer.
The National Treasury revealed that South Africa recorded its largest budget deficit since at least 2004, sending the rand crashing and lowering demand for government bonds.
Data released by the National Treasury on Wednesday showed that the budget moved to a deficit of R143.8 billion for July.
It is the largest deficit since 2004 and wider than the R115.5 billion forecast by economists. There was a surplus of R36.7 billion in June.
Speaking to lawmakers last week, South African Reserve Bank (SARB) Governor Lesetja Kganyago said it was essential that the country reduced fiscal risks.
In June, the bank expressed concern about a growing reluctance from local investors to continue absorbing government issuance.
Demand at Tuesday’s government bond auction was the lowest in nearly two years, based on data compiled by Bloomberg. Bidding was weakest for the longest-dated 2048 notes.
South Africa’s current debt-to-gross domestic product (GDP) ratio is 73%. In nominal terms, the country owes around R5 trillion.
The situation is set to become much worse as the country’s fiscal deficit this year will be around 6% of GDP.
Fiscal deficit is the term used to describe a shortfall in the government’s income compared to its spending.
In South Africa, the state is spending far more than it gets in, which means it has a growing fiscal deficit and needs to borrow money to make ends meet.
Speaking at the SARB’s biennial conference last week, the Bank for International Settlements (BIS) head of emerging markets, Fabrizio Zampolli, wanted that unsustainable public finances can amplify financial instability and drive inflation higher.
“Persistent fiscal deficit can put upward pressure on inflation,” he said. “The fact that this does not happen depends on central bank independence and credibility, as well as government prudence in ensuring fiscal stability.”
Inflationary effects are more significant when a country’s fiscal regime is less concerned with fiscal sustainability, and the impact of fiscal stimulus is much higher in emerging markets like South Africa than in developed economies.
“The effects are bigger in emerging markets because interest rate hikes tend to increase sovereign risk when a country already has a high level of debt.”
Zampolli’s concerns echo those of Efficient Group chief economist Dawie Roodt, who warned that South Africa’s deficit and debt levels are approaching dangerous territory.
“Revenue is under pressure, and the state’s expenses are bigger than the Finance Minister initially expected,” Roodt said.
At the current trajectory, Roodt expects the debt-to-GDP ratio to reach 76% in the current financial year and increase to 80% the year after that.
“A debt-to-GDP ratio of 80% for South Africa is getting into dangerous territory,” Roodt warned.
The growing debt levels mean South Africa is spending more money on servicing the interest on state debt. It will ultimately result in high inflation levels, stifling economic growth.
“Very soon, the private sector is going to demand much higher returns on the increasing risk for funding the growing state debt,” Roodt said.
“Even the South African Reserve Bank is concerned about the growing amount of state debt the banking sector is funding.”