Supplementary Budget: Untenable fiscal position prompts a bold announcement
By Arthur Kamp, chief economist at Sanlam Investments
In its response to the COVID-19 pandemic, the government had to show how it would manage the humanitarian crisis (healthcare and hunger), the negative impact on income and the effect on financial markets. An essential component of the strategy is to keep businesses open and people employed.
The Treasury’s June 2020 Supplementary Budget aims to do exactly this as part of the government’s announced R500 billion economic support package announced late in April 2020. Main Budget non-interest spending increases by R36 billion as new spending allocations of R145 billion aimed at easing the impact of the pandemic, were made possible by a R100.9 billion reduction in baseline allocations and other adjustments of R8.1 billion.
In addition, Social Security funds are also lending assistance. The Unemployment Insurance Fund, for example, had paid R23 billion to 4.7 million employees by mid-June 2020, reflecting the COVID-19/Temporary Employer/Employee Relief Scheme Benefit.
SA’s Main Budget deficit jumps to nearly 15% of GDP
But, whereas the government’s response has been sizeable, appropriate and well-targeted, there is a problem. Given an expected shortfall of R298.5 billion in Main Budget revenue, due to the National Treasury’s estimate of a -7.2% fall in real GDP in 2020, tax relief measures of R26 billion and a collapse in tax buoyancy in the recessionary environment, the Main Budget deficit increases to an expected R709.7 billion in 2020/21. This amounts to 14.6% of GDP compared with the initial February 2020 estimate of 6.8% of GDP (or R368 billion).
At the same time, the consolidated budget deficit is even larger at R761.7 billion (mainly due to the use of Social Security Funds in the order of R49.1 billion). But, the market must fund the Main Budget balance. Including redemptions, the Main Budget gross borrowing requirement is R776.9 billion.
Sourcing the funding requirement locally is problematic
This is a large amount of money to finance. The problem is the limited domestic savings pool. In 2019, gross domestic saving amounted to R739.9 billion. Together with the foreign saving of R153.2 billion, this funded domestic investment of R893 billion. Even if the domestic savings rate increases (as it typically does in a recession) GDP in current prices is expected to decline by -3.5% in 2020. Hence, a limited if any increase can be expected in gross domestic saving in absolute terms relative to last year.
Even after taking into account planned foreign funding (R125.2 billion) and the use of government’s cash balances (R43.2 billion), the Treasury aims to fund R146 billion through short-term loans and R462.5 billion through long-term domestic loans. That implies substantial pressure on domestic savings unless large additional foreign capital inflows materialize this year. This can only be achieved at the expense of a collapse in private sector investment.
The worrying development is the increase in debt service costs from R204.8 billion (4.0%) of GDP in 2019/20 to R236.4 billion in 2020/21 (4.9% of GDP). Apart from crowding out other government expenditure, the real interest rate on government debt is far too high relative to real GDP growth.
Government knows its position is untenable, now or never for economic reform
But, related to this, other than the provision of pandemic related relief programmes, we have a key takeaway from this budget. The government realizes its fiscal position is untenable. Accordingly, it has promised the pursuit of economic reform.
Absent reform, the Main Budget primary budget balance (revenue less non-interest spending) is expected to improve from a deficit of -9.7% of GDP in 2020/21 to -2.3% of GDP in 2022/23 (as the economy recovers and non-interest expenditure declines to 26.8% of GDP from 32.4% of GDP). However, this is insufficient to prevent the debt ratio from increasing to 97.2% by end 2022/23. Meanwhile, the interest bill increases to 5.4% of GDP (R301.1 billion) over the same period.
Cutting spending by around R250bn per year is bold
Given this scenario, the Budget Review announced that government plans to implement economic reforms that would lift economic growth (and hence government revenue) while cutting spending so that the primary budget balance returns to a surplus by 2023/24 – sufficient to ensure the debt ratio peaks at 87.4% of GDP at the end of that year. To put this into perspective, spending reductions and revenue adjustments amounting to around R250 billion are required over the next two years. It’s a bold, ambitious move by the Treasury and it has been endorsed by the Cabinet.
To the extent, the promised adjustments imply tax increases it is likely to defeat the object of the exercise. And, we must wait for the October 2020 Medium Term Budget Policy Statement for details.
In the interim, this year’s funding problem remains onerous.