SA has two choices: cut back spending or face financial crisis

South Africa has two choices: to cut back on spending or induce a financial crisis. There is no option where spending can somehow increase without putting the solvency of the state at risk.

This dire warning comes from Busi Mavuso, CEO of Business Leadership South Africa (BLSA), who says in her weekly newsletter that the country has little choice but to constrain government spending.

“I am not sure if this reality has dawned on government outside of National Treasury. There are only two choices: cut back spending or induce a financial crisis. I say this so boldly because it needs to be said.”

Mavuso says dangerous narratives are promoted with the idea that spending must remain high because somehow it will deliver both social spending and growth. “It will not, and every day when I talk to business people, I can understand why.”

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A state tipping into insolvency is a disaster, she says. From Argentina and Greece to Zimbabwe, it inevitably involves massive disruption to public services, retrenchment of much of the public sector workforce and the collapse in value of government debt that triggers a crisis in the private sector which is the biggest lender to government.

“Investors are always forward-looking. They want to understand the returns they will earn and the risks to those returns. State collapse is a serious risk and the less stable government’s finances are, the more investors have to price for the risk that the government could default.

“This affects the whole economy because state collapse inevitably triggers a major recession and therefore, the riskier government’s finances look, the less the private sector will invest. That means economic growth falls.”

State spending does not drive economic activity

Mavuso points out that if the contrary narrative, that state spending drives economic activity and supports growth, was true the past several years of massive government deficits would have spurred much economic growth.

“Instead, we have had 10 years of declining gross domestic product (GDP) per capita. The problem has never been a lack of state spending. It has been the structure of the economy, failing public enterprises, and crime and corruption.”

She says state spending financed out of debt also hits the economy in another way: it sucks money out of the private sector. If government is leaning on the financial system to buy its bonds, that financial system is then not lending to companies and people to spend and invest.

Mavuso also tackles the issue of social security in government spending. “Improved social security would be a good thing but it cannot be done at the cost of a financial crisis, which would instantly remove the social safety net even as it is.”

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Increases in social spending were successful in the past, such as in the mid-2000s when government finances were strong and spending could be increased dramatically without risking the financial health of the state. “Growth creates the opportunity for social spending, not the other way around.”

When Covid hit, Mavuso says, we immediately knew there were serious risks to government finances. “We lost our investment grade credit rating at the start of the crisis. Public finances were already precarious given the ruining of the state-owned enterprises during the state capture years.”

However, she says, the country received an unexpected reprieve in the form of booming commodity prices during the crisis when, despite the sharp downturn in economic activity during the lockdowns, government coffers were filled by a tax on the production and sale of platinum and many other exports.

“That windfall seems to have led to complacency, but it is now fully behind us. Commodity prices have slumped and mines are retrenching workers because they cannot get their output to the ports given the failing logistics system.

“We already know that government revenue has been falling short of targets because economic growth has been worse than forecast. Already government is having to borrow more than it had expected. As I wrote last week, given the national election next year, the pressures are obvious for increased spending on both welfare and the government payroll.”

Government must hold the line

She says business is clear that the line must be held, as a vicious cycle will ensue if government finances are not kept well under control as it will ultimately lead to low growth and financial collapse.

Godongwana has said that government does not intend to cut spending on infrastructure and social services, but that some infrastructure spending will be paused in the short term. “Of course, infrastructure spending is vital to growth, but protecting government finances is even more vital. National Treasury has been right to hold the line and business confidence is better for it.”

Mavuso says the conversation must move away from government finances and on to how we grow the economy and she proposes these steps:

• fix the logistics crisis that is directly constraining businesses from exporting and generating the revenue they could be paying to government
• accelerate reform of the electricity sector
• consolidate reform of the criminal justice system and get on top of organised crime that is consuming both public and private sector resources
• get the skilled visas system working
• finalise digital migration to allow an expansion of data access
• fix the education system
• improve our international relations
• get off the FATF greylist
• draft industrial policy that supports the development of a competitive, export-oriented economy.

“Growth is the one enduring and feasible way to solve government’s financial position and enable social spending,” Mavuso says.