Over the last few years, the size of the US budget deficit caused considerable angst among investors and ‘prophets of doom’ obsessed over the national debt clock on Times Square ticking over relentlessly. In Congress, fierce budget battles were fought, almost pushing the US into defaulting on its debt.
However, South Africa’s deficit is now larger as a percentage of gross domestic product (GDP) in comparison to the US’s deficit, and the market’s leniency towards emerging economies with deficits has come to an end.
In mid- 2009, both the United States and South Africa tax revenue fell sharply as the economy went into recession, while ‘automatic stabilisers’ and fiscal stimulus measures led to increased spending (see graph 1). The US Federal deficit widened to over 8% of GDP, worrying investors as the Federal debt-to-GDP ratio headed to triple digits. Meanwhile, emerging markets such as South Africa were praised for having smaller deficits and lower debt ratios.
In the US, Federal spending trended broadly sideways for five years, (see graph 2) while tax revenues improved in line with a recovering economy, therefore resulting in the Federal budget deficit being on track to fall below 3% of GDP this year.
Unlike the US, spending in South Africa has soared by 40% over the last five years, with the public sector wage bill doubling as a result of some 250,000 extra civil servants being employed and salary increases well above-inflation. Welfare grant spending also rose rapidly over this period.
While tax revenue growth in the country returned after 2009, there hasn’t been any ‘catch-up’ revenue growth, and it is unlikely there will be going forward. This is mainly because economic growth is disappointing and increases in tax rates could further harm growth.
The resulting large deficits have seen South Africa’s debt ratio climb rapidly (projected to peak above 40% of GDP), while the cost of servicing past deficits has become the fastest-growing item in the Budget.
The global environment has also changed significantly, and markets and credit ratings agencies are no longer willing to give emerging markets with high deficits and rising debt ratios a free pass. South Africa’s budget deficit is almost the highest of all major emerging markets.
In contrast to the US – where the government could finance deficits at record low interest rates – local bond yields have risen sharply over the past year, significantly increasing borrowing costs.
In summary, the South African government will have to reduce spending growth significantly to reduce the deficit to internationally acceptable levels.
Dave Mohr (Old Mutual Wealth)