August 5, 2021

Comment on COVID-19 Pandemic and Unrest Support Package – 5 August 2021

Sometimes economic commentators get it wrong for the right reasons, and often get it wrong for the wrong reasons. They seldom get it right for the right reasons and on occasion, they get it right, but for the wrong reasons.

In March 2021, in ‘Investment Notes 1 of 2021’, we shared our concern for the vulnerability of South Africa’s government finances. Our concern followed on testing four crucial assumptions in the National Budget presented by the Minister of Finance to Parliament in February 2021.

In ‘Investment Notes 1 of 2021’, we concluded that:

The key factors for South Africa’s economic future are:

  • South Africa must achieve the GDP growth assumptions used in the National Budget.
  • The revenue targets used in the National Budget must be achieved.
  • Spending on the public sector wage bill must be curtailed as envisaged by the Minister; and
  • Net financing cost must remain at manageable levels.

GDP growth, revenue targets and the public sector wage bill are all aspects over which Government can exert control. Government cannot control the global interest rate structure that ultimately determines South Africa’s net financing cost.

The global interest rate structure is the canary to South Africa’s economy. If net financing cost remains manageable, South Africa has a good chance of economic advancement, but if global interest rates rise sharply, it would be difficult for South Africa to improve its economic position, even if the public sector wage bill is contained.

We believe that our concerns remain valid and that we got some of the issues right, but not necessarily for the right reasons.

What worked out thus far?

  • The South African economy is well placed to reach the growth assumptions of 3.3% used in the National Budget presented to Parliament. The International Monetary Fund (IMF)’s growth projection for South Africa for 2021 remains above 3% and reflects the higher commodity prices that accompanied the global economic recovery.
  • By all accounts, the revenue collection is ahead of the target contained in the National Budget, as the tax contribution from the mining sector is ahead of expectations.
  • We believe that Government had its expenditure well in hand, as is evidenced by the 1.5% salary increase negotiated with the unions representing government employees. The impact of steps to contain the Covid pandemic and continued relief measures, the cost of maintaining law and order and to repair the damage caused by the rioting, looting and/or insurrection in July 2021, may make it more difficult for Government to keep to its expenditure targets.

What remains a concern?

  • The fourth issue we highlighted in March 2021 remains a concern. In his media statement of 28 July 2021, the Minister of Finance announced measures to support the recovery of the economy and provide relief to the poor in the wake of the spate of violent unrest and the ongoing Covid-19 pandemic. In the statement, the Minister indicated that the cost of servicing outstanding debt is rising to 21% of total government revenue.

In ‘Investment Notes 1 of 2021’, we anticipated that the cost of servicing outstanding government debt would come to 18% of total government revenue (that is, R18 out of every R100 revenue raised by Government is paid towards interest on existing debt). We estimated that, should interest rates around the world rise (fortunately, this is not the case), the cost of servicing outstanding debt would come to 21% of total government revenue in 2022/2023 (that is, R21 out of every R100 revenue raised by Government is paid towards interest on existing debt) and 25% in 2023/2024.

Interest rates around the world have remained low thus far, yet the cost of servicing government debt in South Africa (as a proportion of total government revenue) is rising. The higher ratio of debt servicing cost to GDP can be the result of a greater debt burden assumed by Government, rising interest rates, lower GDP, or a combination of the three variables. South Africa’s GDP is expected to expand at +3% p.a. year on year, and can be excluded from the possible reasons for the higher ratio of debt servicing cost to GDP. The Minister has indicated that Government has not resorted to borrowing more from capital markets. This points to possible borrowings from other sources, or the possibility of higher interest rates in the future.

With the revised indications and expanded social support through the extended “COVID-19 PANDEMIC AND UNREST SUPPORT PACKAGE” announced by the Minister of Finance, we estimate that public service compensation, social security grants and debt servicing costs will continue to dominate government expenditure as percentages of total government revenue:

  • 46% spent on public service compensation (i.e. R46 out of every R100);
  • 21% spent on debt servicing cost of public debt (i.e. R21 out of every R100); and
  • 18% spent on social security grants (i.e. R18 out of every R100).

Despite the tax revenue bonanza from commodity and ore producers, it must be noted that the underlying health of government finances has not improved in equal measure. We believe that the state of government finances remains a risk factor that should be acknowledged in retirement funds’ investment strategies.