Month: December 2022

How to get fiscal policy in the right direction

South Africa needs a plan to reduce the national debt and interest bill

The national debt and the interest bill for SA taxpayers have grown sharply since 2010 – the national debt grew by over R200bn before the Covid-19 lockdowns and by over R400bn in 2021. This year, taxpayers’ interest bill will be of the order of R300bn, compared with R57bn in 2008, while the national debt will approach R4 trillion, equivalent to about 60% of GDP – from a mere 18% in 2008. This is a dangerous trend that needs to be reversed.

In 2008, the interest bill accounted for 8% of all government spending but has since doubled to 16%. At an average 8% yield on the debt, every 1% increase in the average cost of funding the debt adds about R32bn to the interest bill. As the real national debt increases, taxpayers and voters may become unwilling to keep paying this overwhelming interest bill.  Destruction of wealth through inflation of the value of the outstanding local currency-denominated debt will then follow. These types of developments do not come as a surprise to investors. History has made them aware of the dangers of default and they demand compensation for the risks of funding national debts, in the form of higher interest rates paid for upfront.

SA government growth in expenditure, revenue and national debt

SA government growth in expenditure, revenue and national debt chart

Source: SA Reserve Bank and Investec Wealth & Investment, 10/11/2022

In this context, South Africa has been penalised for its presumed inability to reverse course on its fiscal trajectory. High interest rates paid by the government and then passed on to businesses have compensated lenders for expected inflation and the expected accompanying weakness of its currency. The expected weaker rand detracts significantly from the expected returns of foreign investors earning rand incomes when converted to US dollars at some future point in time.

Government interest paid (R billions – LHS) and the ratio of interest paid to total debt (RHS)

Government interest paid (R billions - LHS) and the ratio of interest paid to total debt (RHS) chart

Source: SA Reserve Bank and Investec Wealth & Investment, 10/11/2022

Looking closer at the cause of the rise in the national debt and interest bill, the chief culprit was government spending, which was sustained at a generous rate relative to real GDP after the recession of 2009 and 2010, while the revenue growth lagged. This problem was exacerbated by the lockdowns of 2021. Between 2008 and 2021, government spending after inflation grew by an average of 4% a year, while growth in real revenues increased by an average of 1.2% a year. Real revenues declined by 10% in 2010 and by 16% in 2021. The recession was bad news for the Treasury and higher tax rates were bad news for the economy.

Real growth in national government expenditure and revenue

Real growth in national government expenditure and revenue chart

Source: SA Reserve Bank and Investec Wealth & Investment, 10/11/2022

Much of the extra borrowing undertaken by the government since 2008 has been used to fund consumption spending rather than capital expenditure, a situation that is not helpful for growth. Real spending on compensation for government employees grew by about 30% between 2010 and 2018. Real capex by the government fell away sharply after 2015 and is now 25% below 2015 levels. The numbers employed in government have not increased meaningfully – it is average real employment benefits that have. An expensive patronage system seems to be at work.

Real general government spending on employee compensation and capital expenditure (2010=100, LHS) and the ratio of compensation to capex (RHS)

Real general government spending on employee compensation and capital expenditure and the ratio of compensation to capex chart

Source: SA Reserve Bank (Production and income accounts) and Investec Wealth & Investment, 10/11/2022

The call for fiscal sustainability made by Minister of Finance Enoch Godongwana in his recent mid-term Budget update is founded on the principle of restraining government spending on employee benefits. This is a restraint that is essential for promoting the long-term interests of all South Africans in economic development, including those who now work for or hope to work for the government.

Fiscal reform will be needed to achieve this sustainability. For example, it could extend beyond the objective of reducing the gap between government expenditure and revenue. The government could publish a capital budget and commit to raising national debt only to fund capex. This would help to permanently close the gap between government borrowing and government capex that was allowed to open up after 2008. Honest procurement of well-selected cost-of-capital beating projects should not be regarded as an impossible task.

Growth in national debt and capital expenditure by government

Growth in national debt and capital expenditure by government chart

Source: SA Reserve Bank and Investec Wealth & Investment, 10/11/2022

The climate – how predictable is it?

Abundant summer rain in SA has taken the weather forecasters and climatologists by surprise. They did not expect La Nina to persist for a third successive year- which was thought highly unlikely. La Nina describes an upswelling of cooler water in the Pacific Ocean that brings more precipitation with it – in Southern Africa – and less in other parts of South America.  Its opposite is the little boy- La Nino – associated with warmer seas – and a drier South Africa. The quality of the weather forecasts has apparently been improving but the predictions of the climate models more than 10 days ahead are surely not to be described as confidently made with little margin for error.

Therefore, what confidence should we attach to forecasts of climate over the next fifty or more years? Yet society is being called upon very vociferously to believe in the climate models and their predictions of very harmful global warming. We are therefore being called upon – perhaps better described as being forcefully instructed so by our betters – to eliminate emissions of carbon dioxide – at enormous expense – to limit global warming. Costs of the astronomical order of 200 trillion dollars are bandied about. Which incidentally makes it extremely unlikely that resources of that order of magnitude will be willingly supplied by still highly constrained economies – and their dependents. Many billions of whom still lack clean and affordable energy to heat their shelters and cook their food.

The climate models will not only have to accurately estimate the volume of Co2 and other gas emissions to come and estimate within narrow limits their impact on average temperatures, and also predict how different parts of the planet will respond differently. They will also have to estimate the influence of the other powerful natural forces that will simultaneously and powerfully act on climate. Forces prominent in any climate model will have to include estimates of the variable influence of our lucky old Sun on climate.  I am told by an expert that there is significant disagreement on whether we are about to enter a relatively quiet sunspot cycle, which normally leads to a period of cooling.

Another persistently powerful forces on climate will be ocean flux of which the Ninas and Ninos are an example. To quote the same authority “- the Atlantic Multi-decadal Oscillation (AMO) is a cyclic phenomenon of sea surface temperature anomalies in the North Atlantic Ocean. They switch between positive and negative temperature phases over ~80-year periods. The consensus view is that the AMO is about to shift to a cool phase”.

Climate models are necessarily highly complex and hence prone to error. The climatologists carry grave responsibility for the accuracy of their models. And the politicians will be held responsible for the expected trade-offs of present costs (higher taxes and energy prices) for future- always less than certain – benefits. I am no climate expert. However, I am well-aware of the fallibility of long-term forecasts of the state of any economy. And of the weakness of scenario building that inevitably attaches too much weight to recently observed phenomena. I am conscious that the planning horizon of any firm that commits to capital expenditure is seldom beyond 20 years for very good reasons. Relying on benefits beyond twenty years are too uncertain to influence current outcomes- it is also true of governments and its plans.

It makes good sense to wait and see what dangers and the opportunities that climate change may bring over the long run. A stronger better endowed economy will have the capacity to better manage adversity. The potential danger of global warming adds to the case for faster not slower growth- for more, rather than less resilience. Humans are well practiced in adapting to natural challenges. We can rely on them to cope with continuous climate change.

Relying on ambitious plans imposed top down has not yet proved a useful strategy for humanity.   The plan to control climate through intervening severely in the global market for energy is highly ambitious and top down in a manner not ever embraced before. Yet the search for cheaper, less noxious, less dangerous, and more reliable energy is one of the positive steps for mankind that are still worth taking. What South Africa could be doing with great urgency would be to bring the oil and gas recently discovered off our shores onshore