Government debt holding interest rate cuts back

The government’s massive debt pile means it pays billions in interest each month, which results in higher interest rates for the economy.

This was explained by the Centre for Development and Enterprise (CDE) in the latest update to its AGENDA 2024 series. This series of reports sets out several catalytic actions to reverse South Africa’s decline.

In this report, the CDE explains that the country’s fiscal crisis poses a significant threat to the economy that, if left unaddressed, could have disastrous consequences.

Over the past few years, the country’s fiscal health has worsened substantially.

“Years of large structural gaps between government’s revenues and its spending have wiped out the fiscal progress achieved in the first 15 years of democracy, and the country is now in a much worse position than at the start of the democratic era,” the CDE said.

South Africa’s debt-to-GDP ratio declined from 50% in 1994 to 24% in 2008 but has now risen to 74%.

“Resolving this requires a combination of higher revenues, spending cuts and economic growth,” the organisation said. 

“This is exceedingly difficult, not least because raising taxes or cutting spending tends to slow growth, at least in the short term.”

In particular, high levels of government debt make it difficult for the Reserve Bank to cut rates.

The CDE explained that higher interest rates on government debt result in higher interest rates for the economy. 

This is because of the increase in demand for savings and because of the risk that the government might one day have to inflate its way out of the crisis.

In addition, high levels of government borrowing squeeze out lending to the private sector, transferring scarce savings from more productive to less productive activities.

The CDE’s analysis aligns with research from Allan Gray portfolio manager Thalia Petousis, who found that high government spending and price increases for administered services keep inflation elevated.

Earlier this year, Petousis outlined why a more restrictive rate is more necessary now than in the past.

She identified government spending, which continues to grow faster than tax revenue, as a factor that would make inflation stickier in South Africa. 

She explained that there is a persistent gap between government revenue and expenditure, which is a significant contributor to broader economic instability in South Africa. 

This fiscal problem has necessitated a more hawkish stance from the SARB, which is tasked with maintaining price stability in the country.

The SARB’s challenge is compounded by the impact of administered price increases, particularly in essential services like electricity and water. 

These cost increases have exacerbated inflationary pressures and further constrained the central bank’s ability to loosen monetary policy. 

The delicate balancing act between controlling inflation and stimulating economic growth has become increasingly difficult.

The consequences of elevated inflation are far-reaching. Not only does it erode purchasing power, but it also distorts economic decision-making, discourages investment, and creates uncertainty. 

To combat these effects, the SARB has been compelled to maintain interest rates at relatively high levels, which in turn can dampen economic activity and job creation.

The repo rate and prime lending rate are at 15-year highs of 8.25% and 11.75%, respectively.

Moreover, the government’s reliance on borrowing to finance its deficit has implications for the country’s sovereign risk profile. 

As the debt burden grows, so too does the cost of borrowing, which further exacerbates the fiscal challenge. This vicious cycle reinforces the need for tighter monetary policy, as a weaker rand and higher import costs add to inflationary pressures.

The SARB has repeatedly called upon the government to implement fiscal discipline and reduce expenditures to alleviate the pressure on interest rates. 

While the central bank’s mandate is primarily focused on price stability, a coordinated approach involving both monetary and fiscal policy is essential to achieving sustainable economic growth and low inflation.