South Africa heading for a fiscal cliff

South Africa’s nominal GDP has grown at a rate slower than the country’s long-term interest rates, meaning the country is heading for a fiscal cliff. 

The gap between nominal economic growth and the interest rates the government pays on its debts has widened over the past decade. 

This is primarily due to poor economic growth and the government’s deteriorating creditworthiness over the past decade. 

The Organisation for Economic Co-operation and Development (OECD) explained the potentially disastrous consequences this dynamic could have for South Africa. 

In its latest economic survey of the country, the organisation outlined some of the reasons for South Africa’s poor growth over the past decade and how its economy can be revived. 

One of the biggest threats to South Africa’s future economic growth is the government’s poor financial health and significant debt load. 

This problem began in 2010, as the government increased spending without corresponding economic growth. 

While one deficit is not an issue in itself, the OECD said that persistent primary and full budget deficits have increased South Africa’s debt load to the point where it puts the country’s financial sustainability at risk. 

Public debt has risen from 31.5% of GDP in 2010 to a projected 77% of GDP in 2025, with the government last running a full budget surplus in 2008.

Mounting debt and higher interest rates have led to growing debt-servicing costs, expected to reach 5.2% of GDP in 2025, up from less than 3% of GDP a decade ago. 

In rand terms, this translates to R426.3 billion over the next financial year. The government will spend over R1 billion a day to service its debt.

This growing fiscal pressure limits the government’s ability to fund essential services, meet social needs, and invest in economic growth. 

Over the next three years, the government will spend more on debt-servicing costs than on health, basic education, or social development. 

Financial crisis looms

The OECD explained that the rise in debt-servicing costs is seriously troubling for economic growth and the provision of basic services. 

However, it is even more concerned about how the interest paid on the debt exceeds the country’s nominal economic growth. 

This trend has been sustained for the past decade, with the gap between nominal GDP growth and interest rates widening in recent years. 

It was clear that this is not because South African interest rates are high compared to where they were in the past and outstripping economic growth, but rather that growth has fallen away while interest rates have remained relatively flat. 

The government borrows at an interest rate of approximately 9%, while nominal economic growth stands at around 5%. 

Tax revenue will grow more or less in line with nominal economic growth over time, assuming a steady tax-to-GDP ratio. 

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, which is 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.

The country could, of course, rapidly increase its economic growth to try and ‘grow away’ the debt problem, but this is unlikely. 

Research from Coronation shows that South Africa’s economy needs to grow at 3% per annum to stabilise the government’s debt load at around 80% of its GDP and gradually improve its financial health.

Even at this higher rate of growth, it will take years to stabilise the debt load and then decades to steadily pay it down. 

The graph below shows the gap between South Africa’s nominal GDP growth and the interest rate the government pays on its debt.