Caught in a trap… Gross mismanagement leaves South Africa Inc strangled by rising public sector debt
We interrupt today’s opening paragraphs to fire up our petrol generator as Eskom Limited, the eternal struggler, once again fails to provide enough power for the entire country, despite South Africa experiencing the most significant economic contraction in history. We have been expecting another round of load shedding, an inevitability confirmed by the emergence of a new phrase in our mainstream consumer media. Any of you heard of load reduction? It is nothing other than load shedding by another name. Featuring one of the dozens of mismanaged state-owned entities (SOEs) in our introduction is opportune given the proxy these institutions present of the government of the day.
Plotting and scheming
As government plots and schemes to find the billions of rand needed to fund Eskom’s ballooning debt or resurrect South African Airways, ordinary taxpayers are panicking about how much more of their income government will grab to keep the country afloat. The extent of the debt burden is illustrated in an analysis published by Futuregrowth Asset Management on 3 August 2020, titled ‘The state of South African public finance: How close are we to a debt trap’. The answer, based on the writer’s interpretation of the piece, is nicely captioned in the words of the Elvis Presley song, Suspicious Minds: “We are [already] caught in a trap [and] cannot walk out”. We have intentionally ignored the next line in the popular refrain because there is no love lost between taxpaying Jane and Joe Average and the ruling party.
“I have realised that COVID-19 is a war, with war-like consequences, and that there is no visible way out of the debt trap for South Africa,” opined Andrew Canter, chief investment officer at the firm, in a candid aside to the work completed by his interest rate team. He admitted that South Africa, based on its recent track record, was not going to magically improve its export capability in a competitive world. The report highlighted dozens of key economic indicators that are accelerating in the wrong direction, continuing along trajectories that were often a decade in the making. Futuregrowth published their dire analysis to “share in more detail their thoughts about the possibility of a [South African] public sector debt trap, and its most likely consequences”.
When debt servicing exceeds income
A dictionary definition of ‘debt trap’ describes a situation in which debt becomes difficult or impossible to repay, typically because high interest payments prevent repayment of the principal amount. In English, your income is not enough to pay off the interest being charged on the money you borrowed; you can make monthly payments forever and still owe the same, or more, than your starting balance. Futuregrowth explained that a public sector debt trap resulted from an unsustainable fiscal position, which in turn “implied a situation where the increase in outstanding public sector debt could no longer be slowed by higher taxation and / or decreases in discretionary expenditure”.
This revelation is so chilling that we had to take a moment to reflect. Using the analogy of a snared antelope, we might conclude that South Africa Inc is already caught in a public sector debt trap, and that any attempt to break free will result in more harm than good. The more we struggle, the tighter the noose, until the inevitable moment of release. “A failure to turn the tables will require the issuance of more debt in order to finance the repayment of maturing bonds and the payment of interest on outstanding debt, thereby forcing government into a catch-22 situation,” declared Futuregrowth. They suggested that we could be entering a debt ‘twilight zone’. The phrase, popularised by a 1959 US-produced anthology series by the same name, describes a situation that is undefined, intermediate, or mysterious.
On red flags and twilight zones
We could soon face the dreadful reality of “the average interest rate payable on our outstanding debt exceeding the nominal rate at which the economy is growing”. In the event government is unable to massively curtail its expenditure we may have no option but to monetise debt. Futuregrowth explains: “Debt monetisation will eventually destroy the ability of the central bank to exercise its primary function, being to maintain price stability, thereby running the risk of hyperinflation, in the extreme scenario”. We do not wish to delve too far into the world of economics; but thought it prudent to bullet-point some of the public sector debt indicators shared by the asset manager during their deliberations. We have used their numbering methodology.
- The current / capital expenditure ratio: National Treasury has, since 2012, attempted to enforce a main budget expenditure ceiling to rein in public sector debt. They have failed to make any meaningful inroads in this regard, with the result that available funds are increasingly reallocated from capital expenditure to interest payments. The already poor 11.6% allocation to capital expenditure in 2011/12 will fall to just 8% by 2021/22. If this fact does not concern you, then consider that our last multi-year stretch of meaningful GDP growth was on the back of massive infrastructure spend.
- The public sector wage bill: Local consumers will be familiar with the ongoing debate over public sector wages. We have, for decades, complained about the disconnect between private and public sector salary increases, coupled with poor productivity and service outcomes in most government departments. A telling graph shows how wages in the public sector have outstripped inflation by multiples, going back as far as 2003/04. The result is that 1.3 million public servants, a mere 2% of the population, are set to gobble up 51.4% of the country’s total tax revenue in 2020/21.
- Ratio of outstanding government debt to gross domestic product: “Two important measures to consider when assessing the sustainability of a country’s debt burden are the primary balance and the level of its outstanding debt relative to the size of the economy, or the often discussed debt-to-GDP ratio,” writes Futuregrowth. The latter indicator, which demonstrates a country’s ability to consolidate its budget balance, was trending nicely between 2000 and 2009; but since then has been increasing consistently. Latest forecasts point to an 80%-plus debt-to-GDP ratio by the end of 2021/22.
F: Ratio of interest payments to total government expenditure: The minister of finance has acknowledged the significant impact of debt servicing costs on the budget, stating in February 2020 that this was “the fastest growing category of expenditure”. Futuregrowth observes that the rising debt servicing cost makes for “one more line item that is taking away resources from much needed and potentially more productive capital expenditure”.
An ever-worsening trend
The asset manager combined its various economic indicators into a holistic fiscal strength score for the country. This score has been in decline since the Global Financial Crisis, circa 2008, and has now reached its worst level since 1996. Futuregrowth concludes that our fiscal strength decline is due to “a combination of macroeconomic developments and years of poor fiscal management by government and SOEs”. And unless something staggering happens to reduce expenditure, we risk becoming more entangled in the public sector debt trap, further sovereign ratings downgrades, and steepening yield curves.
We borrow our conclusion from Presley, who may have summarised the trust relationship between South African taxpayers and government as follows: “We cannot go on together … and we cannot build our dreams … on suspicious minds”.
