South Africa heading for financial crisis

South Africa is heading for a financial crisis, with the government’s debt burden reaching unsustainable levels and the local economy buckling under this pressure. 

This is feedback from Efficient Group chief economist Dawie Roodt, who outlined South Africa’s deteriorating state finances and called for significant changes to be made to avoid disaster. 

Roodt explained that South Africa’s debt burden is significantly worse than commonly reported, with the national government’s debt exceeding 75% of GDP in the past financial year. 

If local government debt and all state-owned enterprise (SOE) debt were to be included, state debt as a share of GDP would be around 95%. 

This is nearing the point where the local economy cannot sustain the burden of funding the government and its machinery through taxes. 

Roodt told Newzroom Afrika that altering this course would be extremely difficult and painful for many South Africans, with tough political tradeoffs that would have to be made. 

Certain areas of government spending, such as social grants, are exempt from cuts, as the country’s poor economic performance over the past decade has left many South Africans unable to support themselves. 

“We, as South Africans, cannot allow our fellow citizens to die of hunger, for example. This is a major problem that has to keep paying billions in social protection because of poor economic performance,” Roodt said. 

However, other areas, such as education and the public sector wage bill, offer low-hanging fruit that can be relatively easily attained if the political will exists. 

Roodt said the political will to make tough decisions is desperately needed, as the state’s financial challenges are reaching crisis levels. 

“We are in deep, deep trouble. If you include all state debt, such as local authorities and SOEs, debt-to-GDP is at 95%. This cannot be resolved gradually. It requires urgency,” Roodt said. 

“If you are in this sort of trouble, you need quicker and more decisive action. It cannot be gradual, and tough decisions have to be made.” 

Roodt pointed to Javier Milei’s example in Argentina as a way for the government to quickly cut state expenditures without sacrificing economic growth. 

“Milei, Argentina’s president, is cutting back on state expenditure and has strong political support because the public understands the financial difficulty the country is in,” Roodt said. 

“What is important in South Africa is to inform the public that the state is in very deep trouble financially and that we are heading for even more trouble if no changes are made.” 

Roodt explained that the sooner the changes are made, the less painful they will be for the country and individuals. 

“The day is going to come, especially if there is a political force behind it like Donald Trump, that will make change happen rapidly and then financial markets will really punish us.”

“People must know this: if we continue on this trajectory, we are heading for a financial crisis that will have severe consequences for South Africa.” 

The government’s debt burden

The South African government’s debt burden has ballooned over the past decade, crossing 75% as a share of GDP in the past financial year. 

This is a far cry from the 25% seen when the government last ran a full budget surplus in the 2007/08 financial year, with increased state spending not coming with improved economic growth. 

Most worryingly for South Africa is the high interest rate the government pays on this debt, with investors demanding a significant risk premium to hold local debt. 

This means that due to the country’s lacklustre economic growth, the interest rate the government pays on its debt is higher than South Africa’s nominal economic growth.

Currently, the government borrows at an interest rate of around 9%, while nominal economic growth hovers around 5%. 

Old Mutual Wealth investment strategist Izak Odendaal explained that this is deeply problematic as it means the growth in interest payments will outstrip tax revenue growth, which grows largely in line with economic growth. 

This gap between interest rates and growth, sometimes expressed as r>g by economists, renders borrowing unsustainable since debt compounds faster than the income needed to service it.

This sits at the core of South Africa’s fiscal challenge, as debt-servicing costs are the fastest-growing expenditure item in the budget, with the government having to spend over R1 billion a day on interest payments. 

Since the government cannot directly control economic growth or the interest rate at which it borrows, determined by the bond market, it must focus on reducing its borrowing requirement. 

This is called ‘fiscal consolidation’ but is necessarily painful since it relies on some combination of higher taxes or less spending.

“Unfortunately, South Africa has no easy choices left. All we can ask for is that the difficult choices are made wisely,” Odendaal said.  

From investors’ point of view, it would have been positive if the Treasury was prepared to take the politically unpopular step of raising VAT rates by two percentage points. 

The fact that the Cabinet was not sufficiently briefed now appears clumsy, but it’s not sinister. The pushback against the VAT increase means the National Treasury must return to the drawing board. 

Importantly, however, the issue is not the principle of fiscal consolidation but rather how best to achieve it.