It’s only a debt trap when the bond market says so

ARTICLE BY

SHARE THIS POST

South Africa’s current fiscal path is unsustainable. Taken at face value, the announced bail out of state-owned companies and continued weak income growth has, effectively, severely dimmed the hope of fiscal consolidation in 2019/20 and 2020/21 as a Main Budget deficit of close to 6% of GDP is now expected in both years on current information. That compares with budgeted deficits of 4.7% of GDP in 2019/20 and 4.5% of GDP in 2020/21.  At the same time, the government debt ratio is forecast to continue climbing well above 60% of GDP over the medium term.

Further, government recorded an exposure (borrowing and interest accrued) of R372.4 billion out of R483.1 billion worth of guarantees extended to public institutions by end-March 2019.

South Africa is also at the point where non-interest spending must be constrained to accommodate interest payments. In the fiscal year ending March 2008, interest payments on government debt amounted to around 2.5% of GDP. In the current fiscal year ending March 2019, interest payments are forecast to amount to more than R200 billion, which is close to 4% of GDP (or 14.7% of total Main Budget revenue).

The level of debt does not tell us much. However, if the real interest rate paid on government debt continues to exceed the real growth rate of the economy, then, increasingly, interest payments will be funded by increases in debt – unless the government can cut back expenditure in other areas (assuming there is a limit to raising taxes relative to GDP).

The point is, left unchecked, South Africa’s current fiscal trends are unsustainable. But, is this a debt trap? A debt trap is not a clearly defined concept. Broadly, the answer depends on whether or not economic agents believe that the government can (and will) arrest the persistent upward momentum in the debt level.

Currently, government is obtaining the funding it requires in the bond market and has not needed to turn to the printing press. In addition, a supportive global backdrop of historically low developed market risk-free interest rates is helpful, although the real rate of interest at which the government issues new bonds has been climbing steadily in recent years.

But, in the absence of credible, targeted interventions to stabilise the debt ratio and protect the balance sheet of the state (by restructuring state-owned companies to effectively deal with the accompanying contingent liability risk) an unsustainable position would likely turn into a debt trap – a situation in which it is clear that an uncontrollable, sustained increase in the debt ratio is unavoidable.

The expected future direction of the primary budget balance is a key indicator of the government’s intent. The Main budget primary budget balance (revenue less non-interest spending) is expected to amount to close to -2% of GDP in 2019/20, compared to an initial expectation of -1% of GDP (largely reflecting the Eskom bail-out). But, given the current real interest rate government is paying on its debt and the weakness of GDP growth, the primary budget balance needs to improve in the medium term to a surplus in order to stabilise the debt ratio.

What should be done? The answer is to grow the economy. But, until such time as we manage to lift potential growth, we must consider other alternatives. We could increase taxes. The Treasury has indicated additional tax-raising measures will be implemented in next year’s budget. But there is limited scope to do so. Corporate profits, as recorded in South Africa’s national accounts, are depressed. Also, the level of tax on the income and wealth of individuals relative to household income is at its highest level ever. And, a VAT rate hike would be unpalatable.

We could also sell assets, which would likely be warmly received by market participants. However, whereas privatisation can lift efficiency, it is often a stopgap measure that does not alter the underlying problem.

Rather, attention should switch to government expenditure. But this cannot occur in isolation. Simultaneously, we will need to find a way to encouraging private sector fixed investment to sustain growth. The bottom line, however, is South Africa’s government spending must reflect the reality of a low potential growth rate. This will be difficult. Government’s consolidated budget shows expected total expenditure of R1 826.6 billion in 2019/20. Interest payments cannot be cut.  Further, given an unemployment rate of 29%, it is not feasible to cut social protection (R207 billion is budgeted for 2019/20). And, looking ahead, upward pressure seems likely on health expenditure (expected at R223 billion in the current fiscal year). Ostensibly, in the absence of government announcing an alternative arrangement, support for Eskom (R49 billion in 2019/20, R56 billion in 2020/21 and R23 billion in 2021/22) cannot be cut. This leaves a “balance” of R1 145 billion (using 2019/20 as an example to demonstrate the relative size of spending components) on which expenditure cuts are likely to be focused. To put this in perspective, an improvement in the primary budget balance of 1% of GDP is equivalent to R50 billion.

Despite these difficulties, though, looking ahead over the Medium-Term Expenditure Framework, one looks to the Treasury to deliver expenditure cuts relative to the current baseline, with the focus on consumption spending rather than capital expenditure when the Medium-Term Budget Policy Statement is read in October 2019.

Fiscal policy cannot be allowed to continue drifting in the wrong direction. The only plausible option is to tackle the problem now, before it becomes insurmountable.

Subscriber Terms and Conditions

  1. APPLICATION OF TERMS
    • These terms and conditions (“Subscriber Terms”) apply to the subscription by any qualifying member of the South African Underwriting Managers Association NPC (“SAUMA”) to the services and benefits offered by FIA Services (Pty) Ltd (“FIA Services”) under the SAUMA affiliation arrangement (“Subscription”).

  2. NATURE OF SUBSCRIPTION
    • A Subscription under this arrangement:
      • does not constitute membership of FIA NPC;
      • does not confer any voting rights or governance participation in FIA NPC; and
      • is governed solely by the contractual relationship between the Subscriber and FIA Services.

  1. ELIGIBILITY
    • To qualify for the Subscription, the applicant must, at the time of application, be a current paid-up member of SAUMA.
    • FIA Services will verify the applicant’s SAUMA membership status with SAUMA prior to activation, and may re-verify such status periodically.
    • If a Subscriber ceases to be a paid-up member of SAUMA, the Subscription will correspondingly be terminated.
    • Applicants are required to authorise FIA Services to confirm their SAUMA membership status with SAUMA as part of the application process.

  1. SERVICES
    • The Subscription entitles the Subscriber to the following benefits:
      • Complimentary access to the FIA CPD Platform;
      • Complimentary access to the FIA Insight Magazine (digital edition);
      • Advertising opportunities on FIA platforms at a discounted rate of 15% (fifteen percent) off the prevailing published rates; and
      • Invitations to attend FIA Technical Webinars annually.
    • FIA Services reserves the right to update, vary or substitute the Services from time to time, provided that the overall value and nature of the benefits remain materially the same.

  1. FEES AND PAYMENT
    • The monthly subscription fee is R260.00 (two hundred and sixty rand) for up to seven registered individuals (Key Individuals and Representatives), and R36.00 (thirty-six rand) per additional registered individual thereafter, excluding VAT.
    • The Subscriber shall provide FIA Services with the required details of each individual to be registered under the Subscription for the purposes of activation and billing.
    • All fees are exclusive of VAT, which shall be charged at the prevailing statutory rate.
    • Subscription fees are reviewed annually in March and may be adjusted with effect from 1 April.
    • Any changes to the Subscription, including but not limited to the number of Representatives and Key Individuals registered under the Subscription, may only be effected once annually during the annual review period in March of each year, with such changes taking effect from 1 April.
    • Subscription fees shall be billed monthly in arrears, unless the Subscriber elects an annual billing cycle at the time of application.
    • The Subscriber shall ensure that all billing information (including contact details, authorised signatories and bank account details) is kept accurate and up to date.
    • Non-payment of subscription fees may result in suspension of access to the Services until such fees are brought up to date.
    • The Subscriber acknowledges and agrees that all subscription fees payable under these Subscriber Terms may be collected by way of debit order, which shall be processed by the holding company, FIA NPC (The Financial Intermediary Association of South Africa), on behalf of FIA Services. Payment to FIA NPC shall be deemed to constitute valid and sufficient discharge of the Subscriber’s payment obligations to FIA Services under these Subscriber Terms.

  1. ONBOARDING
    • Onboarding will be conducted as a Subscription with FIA Services under the SAUMA affiliation arrangement.
    • Onboarding will not confer FIA NPC membership status or any associated rights.
    • Onboarding is conditional on confirmation of the Subscriber’s current SAUMA membership at the time of application

  1. DATA PROTECTION
    • FIA Services will process all personal information in accordance with the Protection of Personal Information Act 4 of 2013 (POPIA) as set out in our POPIA policies.
    • By subscribing, the Subscriber authorises FIA Services to confirm their SAUMA membership status with SAUMA and to process personal information for the purposes of fulfilling the Subscription.

  1. TERMINATION
    • The Subscriber may terminate the Subscription by giving FIA Services one calendar month’s written notice.
    • FIA Services may terminate the Subscription on one calendar month’s written notice, or immediately if the Subscriber breaches these Subscriber Terms and fails to remedy such breach within 14 (fourteen) days of receiving written notice.
    • Termination of the SAUMA–FIA Services affiliation agreement shall not automatically terminate these Subscriber Terms.
    • Termination by the Subscriber shall not relieve the Subscriber of liability for any subscription fees accrued up to the effective date of termination.
    • FIA Services may suspend or terminate the Subscription with immediate effect in the event of non-payment of fees by the Subscriber.

  1. GENERAL
    • These Subscriber Terms are governed by the laws of the Republic of South Africa.
    • Any disputes arising under these Subscriber Terms shall be dealt with in accordance with the dispute resolution provisions contained in the FIA NPC membership terms and conditions, as modified to reflect that the contractual relationship is with FIA Services.
    • Any notices required under these Subscriber Terms may be validly delivered by email to the addresses provided in the Subscriber’s application form, and such notices shall be deemed received on the day of transmission if sent during business hours.
    • The Subscriber may not assign, cede or transfer any of its rights or obligations under these Subscriber Terms without the prior written consent of FIA Services.
    • No variation of these Subscriber Terms shall be of any force or effect unless reduced to writing and signed by both FIA Services and the Subscriber.