There are disturbing narratives that emerge from time to time from respected social activists and community leaders in how to deal with the macroeconomic policy setting during the ongoing Covid-19 pandemic.
For some reason, my observations have been that it’s those without training in macroeconomics that make calls for abandoning fundamental principles of how the economy works, that if we dare ignore them, South Africa will jump straight from a Covid-19 inflicted health and economic crisis into another economic crisis of our own making. These calls are reckless and policymakers must guard against the pressures to destroy the credibility in economic management that was gained over a long period of time, or else risk economic ruin in the years ahead.
Against the backdrop of Covid-19 economic decline, which is still unfolding and will likely be with us for the remainder of this year and part of 2021, some have called for increased government spending through debt. The rationale provided is that the current disaster is not a South Africa crisis alone, and that almost all countries will end up with more debt than before Covid-19 hit. This is a sensible call, and indeed many countries have announced unprecedented fiscal packages to deal with healthcare expenditure needs, protecting workers losing jobs through some version of basic income support, and helping companies with cash flow and liquidity shortfalls.
Countries such as Japan, Singapore, the United States, Canada and Thailand have announced fiscal packages of between 10% and 25% of GDP. South Africa has also announced a R500bn (10% of GDP) fiscal package of which about R100bn (2% of GDP) will be borrowed from global lenders, while R200bn will come in the form of a loan guarantee scheme. While the impact of the R100bn to be borrowed offshore on the state’s debt appears low, the credit scheme will create a corporate sector debt burden that will need to be paid back in future.
While the current increase in debt is necessary, it is the suggestion that we should not be worrying about debt because we are in the middle of a global crisis that is worrying. Those pushing this narrative have memories like that of fish, very short. The potential collapse of the euro area was sparked by the euro debt crisis, itself a partial consequence of how the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) countries mismanaged their debt in the aftermath of the global financial crisis. This year Argentina has defaulted on its debt for the second time this century (the previous default took place in 2001) with the consequence that its access to capital markets is difficult, and when it can access lending the cost of debt is very high.
These are examples of countries that are still dealing with the cost of unsustainable debt levels many years later. It’s possible that when they were spending the borrowed money they too may have thought debt was not an issue. With the benefit of hindsight, we know that unsustainable debt breeds fertile ground for financial crises and economic ruin.
The seeds for an unsustainable debt path for South Africa have been planted over the past decade, and the suggestion to not worry about debt now will water these seeds to life.
South Africa’s debt-to-GDP ratio has been on an unsustainable path since 2017, and it remains unsustainable. By unsustainable, in simple terms, is meant that that the country's debt-to-GDP ratio continues to rise, increasingly demanding a greater portion of government revenues to service it, thus crowding out other productive spending in such a way that economic growth is eventually constrained. Estimates for South Africa’s debt-to-GDP ratio puts it above 80% of GDP by 2022/2023.
With the lockdown reducing business profitability, household consumption and employment, it is now consensus that economic growth will decline more than 6% this year. The Reserve Bank estimates a contraction of about 7% this year. The debt-to-GDP ratio will rise due to this. In addition, tax revenues will also decline, which means there is going to be significant pressure on spending.
God forbid, should the Covid-19 crisis last longer than currently expected, these unprecedented bad economic outcomes will worsen. This, however, is a risk and not a base case. The true concern that policymakers should worry about is this: in a world where deglobalisation is escalating, global capital will increasingly be selective in where it invests. Countries that will emerge from the coronavirus crisis with better economic fundamentals will reap the rewards of being able to attract foreign direct investment.
Prudent fiscal management should place SA's debt on a sustainable path as a demonstration of good economic management. This will further create room for monetary policy to curb inflation should it increase in future without being constrained by a possible increase in debt service costs for the state. This will effectively also prevent monetary policy dominance by fiscal policy, where the central bank will be unable to raise rates to control inflation because it would make the debt path unsustainable through high debt service costs.
All indications suggest that inflation is not a short- to medium-term problem but that debt is a problem now and has been for some time, that’s why we are now effectively two notches below investment grade. This is why National Treasury must come up with a credible plan for a post Covid-19 debt consolidation path, which should be underpinned by economic reforms that boost economic growth.
As for those that call for not worry about debt, they should care to look at the growth in the country’s interest bill over the past decade – it’s now north of 15% annually. They should also look at the economic ruin that other countries have gone through, the PIIGS and Argentina have many lessons, including the fact that mismanaging debt is one direct way to invite the International Monetary Fund to come and take over a country’s economic policy making independence. South Africa, with its social structure, can not afford to give up the ability to make its own policies.
Isaah Mhlanga is chief economist at Alexander Forbes