South Africa trapped in a vicious financial cycle

South Africa’s lack of economic growth has put the government’s finances under immense pressure, with it increasingly having to turn to debt to fund its extensive spending programmes. 

With a significant number of South Africans dependent on the state for their livelihood, through social grants, this has a momentum of its own. 

However, the government is running out of room to raise more debt to continue plugging its budget deficit, and, without growth, it will have to turn to SARS to squeeze more revenue from an already strained tax base. 

In turn, this will subdue economic growth as capital will flow out of the productive private sector and households to the government, which has been a historically poor allocator of resources. 

As a result, a vicious cycle has been created, threatening to plunge the country into a serious financial crisis. Now, tough decisions need to be made to avoid the worst consequences. 

This is feedback from Efficient Group chief economist Dawie Roodt, who outlined South Africa’s financial difficulties in a recent interview with the State of the Nation podcast. 

Roodt explained that, fundamentally, South Africa’s financial crisis is a manifestation of a stagnant economy. Without growth, the pie does not grow and, thus, individuals get poorer and the state collects less revenue. 

“The Minister of Finance depends on a growing economy to fund the state. Without a growing economy, it is very difficult to grow tax revenue without negative consequences,” Roodt said. 

Everything else being equal, tax revenue typically grows in line with nominal economic growth. Without faster growth, increased revenue has to come from a rise in tax rates or more efficient revenue collection. 

“We do not have an economy that is growing. We have huge levels of unemployment, massive dependency on the state, and increasingly ambitious spending programmes,” Roodt said. 

“So, state revenue will come under pressure. It is under pressure already. This means that the government has to look at ways to increase revenue in a stagnant economy.” 

So far, the National Treasury has consistently turned to SARS to raise additional revenue through enhanced collection. 

While this initially comes from relatively easy gains in closing the tax gap, estimated at R800 billion by SARS, it will eventually lead to a more aggressive revenue service. 

As a result, more capital will be taken out of the productive private sector and put into the hands of the government, which is a historically poor allocator of resources. 

This will limit economic growth, increase the pressure on government revenue, and force SARS to be more aggressive – creating a vicious cycle.

Economic growth is the only sustainable solution

A faster-growing economy is the only sustainable solution, and it is the only way to increase government revenue without negative consequences. 

Despite the dependency of millions of South Africans on the state, it also faces increasing pressure from servicing its own debt. 

Since its last full budget surplus in 2007/08, the state has racked up a significant debt load worth over R5 trillion and 76% of worth of GDP. 

The cost of servicing this debt has been the fastest-growing expenditure item in the government’s budget over the past few years. 

It has begun to crowd out spending in other areas of the economy, with the state forking out over R1 billion a day to service its debt in the current financial year. 

More worryingly, the interest rate the government has to pay on its debt is higher than South Africa’s nominal GDP 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.

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.