The coming showdown (II)

RW Johnson writes on SA's ballooning state debt, and the options for dealing with it

President Ramaphosa has announced, with surprising enthusiasm, that South Africa is witnessing “the total destruction of the economy”. “We are resolved”, he continued, “not merely to return our economy to where it was before the coronavirus but to forge a new economy – our new economic strategy going forward will require a new social compact among all role players – business, labour, community and government – to restructure the economy”.

The thought is much the same as Blade Nzimande's “We can't return to the crisis before the crisis” but unfortunately this sort of cheerful voluntarism is rather out of place. Indeed, Ramaphosa seems seriously out of his depth if he really imagines a new economy can be conjured up by some sort of happy-camper social compact.

More to the point, look at the facts. Edward Kieswetter, the head of SARS, estimates that SARS will be short of an extra R285 billion in tax receipts – and that is on top of a R370 billion deficit to start with. BASA (Business for South Africa) predicts a fall in GDP of between 10.3% and 16.7% - and we don't know how much longer the lockdown will continue, so that figure could get even worse. Forecasts of job losses vary between one million and seven million.

What we are looking at is a picture of terrible economic and social distress. Child malnutrition cases have already increased and there will be more. A large though unknown number of small businesses have already been destroyed and will not re-appear. The entire aviation and tourism industry is missing in action and could stay dormant for some time.


Without much doubt this will have been the coup de grace for many of the weaker municipalities and in effect they too may now disappear. In the rest of Africa local government only survives in the biggest cities and we may follow that pattern. Even cities as important as Msunduzi (Pietermaritzburg) and Mangaung (Bloemfontein) were both already under administration before the Covid-19 crisis.

In other words, if the lockdown ended tomorrow and the virus went away with it, we would still be looking at enormous damage. This is not the basis on which to build any kind of new economy and in fact all one could hope to do is to try to nurse the old economy back to some sort of health – so what Ramaphosa and Nzimande say should be dismissed right away.

However their unrealism is widely shared. There are insistent calls on the Left for the introduction of a universal income grant. Note that this would not only be paid to the unemployed but to those in work as a sort of wage top-up. This is a wholly fantastic proposal, a huge new spending programme at a time when there is not enough to pay for the programmes already in place. Moreover, it defies logic that, in effect, all those lucky enough to be in work – at a time of mass unemployment – should all get wage increases.

Cosatu have also called on Tito Mboweni to make his revised emergency budget on June 24 a “workers' budget”, I.e. that he should use his slender means to give the already well-paid public service workers a wage increase. All such demands for higher wages should be set against the background that South Africa has already priced itself out of competition with its emerging market competitors by having much higher wages uncompensated for by higher productivity.

Cosatu is in fact asking for an exact repeat of what Zuma did in the 2009 crisis. The IMF were utterly scandalized that he chose that moment to give a large increase to those very same public service workers – simply financing their extra consumption – when the crying need was for extra infrastructural spending, both because it would mean growth-inducing investment and because it would provide extra jobs for the unemployed.

As the IMF angrily pointed out, what Zuma was doing was sharply increasing inequality. And this is exactly what Cosatu is now asking for again. Moreover, the Cosatu spokesman, Sizwe Pamla, was annoyed that extra pay for the public service was regarded as consumption expenditure: public servants, he said, were “carrying the economy on their backs”. Thus, amazingly, the IMF is far to the left of Cosatu on the issue of inequality.


In general, the unions need to realise that we are entering a period where those with jobs are the lucky ones and that wage demands need to be weighed very carefully indeed. Only a few months ago, after all, workers at SAA went on strike demanding higher wages. Over eight days they cost SAA R416 million in lost revenue. Now the same unions find themselves volunteering wage cuts of 49% in a vain attempt to save their jobs. This casts a strange light on all the angry rhetoric and toyi-toying we saw then.

As may be seen, we face several kinds of economic problems. There is no shortage of cheerful suggestions – to do more to help small businesses, to launch a vast public works programme to mop up unemployment, to spend more on health and food parcels and so on – but all of these nice ideas involve the state going even further into debt and already it is the size of the debt mountain that has really gripped the attention of financial analysts.

Remember that for a middle income developing country like South Africa debt should ideally not exceed 60% of GDP. And then realise that it looks as though by 2022-2023 our debt will have reached 90% of GDP and, if you add in the state's other liabilities (guarantees of Eskom's debt etc) that figure will be around 110%. Already the Land Bank, Denel and ACSA are queuing up asking for large state subsidies just so that they can survive.

Now it is true that Italy and Japan, for example, both have a national debt higher than 110% of GDP that, but then also remembered that they will only pay around 1% interest on their debt while South Africa is paying around 9% on its debt. At this point the Left, somewhat incongruously, is prone to make proud speeches about South Africa having strong and deep capital markets, so don't worry, we will simply issue a whole lot more government bonds and we South Africans will buy all those extra government bonds ourselves.

But this won't wash. Almost certainly there is nothing like enough domestic demand for that. Secondly, to sell such an enormously increased volume of bonds the government might find itself paying even higher rates of interest. Third, if that succeeded it would crowd out demand for South African equities, creating a major problem for industry. Fourth, if the rest of the world sees South African debt climbing to those stratospheric levels, there would be further huge capital flight out of South Africa and the Rand would collapse.

So this is a situation which has to be faced – and soon. It would be folly to imagine that the markets would passively watch South Africa's debt reaching 110% in 2023. If the country does proceed in that direction, then something is likely to give long before then. In other words, we need decisive action very soon indeed. There are essentially three options:

1. Attempt to go it alone without IMF help, carrying out the structural reforms necessary to ignite much faster growth. This would require very steep spending cuts.

2. Accept the arguments of the devotees of Modern Monetary Theory and simply print the extra Rands with which the Reserve Bank could buy all of our own debt.

3. Approach the IMF for help and agree to the programme of structural reforms on which an IMF loan would be conditional.

Let us take the first alternative. We have to avoid a debt trap – viz. a situation in which one is borrowing merely in order to pay interest on one's existing debt. Etienne le Roux of Rand Merchant Bank has helpfully done the figures. If we assume that we pay only 8% interest on our debt (currently the figure is higher) and that inflation is 4%, in order to stabilize the country's debt at 90% of GDP we need to grow at a real rate of at least 4.5% per annum, which is dramatically faster than we have grown for over a decade.

Alternatively, if we continue to grow at only 1% per annum then we will have to cut budget spending by 8%-10%, using the budget surplus to slowly pay down our debt. (A cut of that size would probably mean retrenching very large numbers of public service workers and also cutting or at least freezing the wages of those who remain.)

We could also try to combine these two approaches, carrying out the structural reforms necessary to trigger higher growth and probably also conducting asset sales (ie. by privatizing SOEs). But even so there would have to be deep and painful spending cuts. Taxes would doubtless rise but there is limited scope for that.

In effect taking this route would mean having to carry out many of the structural reforms which would have been required under an IMF bailout but doing so of our own accord. Clearly, this route would be very unpopular with the trade unions, the SACP and probably with the ANC. Since the government would be desperately trying to cut public spending wherever possible it would mean that NHI, a sovereign wealth fund, a state bank and so forth would all have either to be cancelled or at least put on hold for the duration of the programme. Since obtaining foreign investment would be more important than ever, logically this would also mean cancelling Expropriation without Compensation. The structural reform and fiscal consolidation programme would take a number of years and would make elections very difficult for the ANC.

Secondly, we could take the Modern Monetary Theory (MMT) route. This has been put forward by Duma Gqubule of the Centre for Economic Development and Transformation, Chris Malikane of Wits and Ace Magashule. All these proponents come from the “radical economic transformation” group and Malikane has also been associated with Black First Land First.

Essentially their argument is that since South Africa's debt is largely in Rands, all that is needed is for the Reserve Bank to be made a straightforward servant of government policy. The Bank will then print whatever amount of money is required to buy up the government's bonds and thus the debt problem is solved. They point to the fact that the Bank has recently intervened in the bond market – and simply want it to do this a great deal more.

In fact the Reserve Bank has been emphatic that it has not engaged in “quantitative easing” but that it merely intervened to stabilize the bond market when it looked like a bond auction might fail for lack of investors. The Governor of the Reserve Bank, Lesetja Kganyago – who is also chairman of the IMF's Finance Committee – is decidedly not of this point of view and would probably resign rather than be part of such a policy. The same probably applies to Tito Mboweni, a previous Governor of the Bank.

It is true that the Federal Reserve, the Bank of England and the European Central Bank all engaged in quantitative easing in the wake of the 2008 financial crisis when there was a clear need for a public stimulus to rescue a depressed economy on the verge of deflation. They were able to do this successfully partly because the dollar, Euro and Pound are all reserve currencies backed by powerful economies.

On the other hand when Zimbabwe and Venezuela have done the same thing the result has been disastrous – hyper-inflation and a thriving black market in harder currencies. Zimbabwe is now on the fourth iteration of the Zimbabwe dollar after that currency has previously collapsed three times and had to be withdrawn. The fourth iteration – so-called bond notes – have also collapsed in value against other currencies and have not been widely accepted by the Zimbabwean population which tries as far as possible to deal in other currencies.

MMT has not been accepted by most economists – the Financial Times said that if it had appeared in Wonderland, Alice would rightly have been very suspicious of it – but a number of countries have at least dabbled with quantitative easing without disastrous consequences. Optimally, it would appear that if an economy is very depressed and if there is deflation or at least 0% inflation, it may be possible for the central bank to print more money as a way of pumping up demand without this necessarily resulting in inflationary consequences. It is possible that South Africa in the wake of the Covid-19 crisis might provide such circumstances.

However to attempt to deal with South Africa's debt by this means would be a tremendously ambitious project. For a start, inflation is already 4%. But we are also talking of a debt so vast that the Reserve Bank would have to print extra money to the tune of many hundreds of billions of Rands every year in order to buy government bonds. The risks of inflation taking off and of our central bank losing all credibility (as has happened in Zimbabwe) cannot be denied.

Obviously, the appeal of MMT is that it avoids having to choose either of the other alternatives, both of which have high political costs. However, it should be pointed out that even if MMT worked without highly inflationary consequences, it would pose no answers to the underlying problem of South Africa's loss of competitiveness.

Without major structural reforms South Africa's economy will not resume a growth path sufficient to stop real per capita incomes from falling year on year, as they have for the past five years. The ANC's mining legislation has made our mines so uncompetitive that no new mine has been sunk in the past decade. Almost all of Africa is growing far more rapidly than South Africa because our wage rates, labour laws and BEE legislation make us uncompetitive. It is beyond comprehension that South Africa's people will tolerate ever-falling per capita incomes and ever-rising unemployment. So in practice there is no way to avoid structural reforms.

The third alternative is that South Africa would ask the IMF either for a Stand By Arrangement or an Extended Credit Facility, either of which would see South Africa acquire a large loan and commit to carry out a programme of major structural reforms. These would effectively be policed by the IMF which hands over a loan in tranches with each tranche dependent on the implementation of the required reforms.

Stanley Du Plessis and Malan Rietveld have recently laid out the case for this option.[1] It is striking that they do not consider MMT a real option at all. Instead they point out that South Africa's need to sell a much larger volume of bonds will inevitably push up bond rates over 10%. Taking into account the much higher deficit caused by higher public spending due to Covid-19 and the fall in tax revenue as well as the general economic contraction also caused by the virus (which it could take several years to repair) they foresee a situation in which debt interest payments could grow from the present 16% of government revenue to a huge (indeed, implausible) 30%..

Governments which find debt interest payments rising like that realise they are on a runaway train. They resort to increasingly desperate gambits: they announce unilateral debt restructurings, they try to inflate away their debts by a deliberate policy of pushing up inflation, they raid pension funds, they make huge and painful cuts in expenditure, and they often damage their reputation in bond markets for years ahead by resorting to prescribed assets, unilateral interest “holidays”, capital controls and so on. In the end they default, perhaps because they get shut out of credit markets altogether. Really this whole death agony is just a prolegomenon to default.

Rather than go through this Du Plessis and Rietveld advocate that South Africa enter an IMF programme. They point out that not only would an IMF loan be considerably cheaper than raising money in the bond markets but that because entering such a programme is a signal to the markets that major reforms really are at hand and because IMF involvement generally increases market confidence, the effect would probably be to lower the interest rate charged on our bonds. The same confidence factor also often results in an increase in both foreign and domestic investment.

It is true, of course, that entering such a programme entails a de facto loss of sovereignty as the country is forced to sign up to IMF conditionalities. However, if the programme is successfully carried through that loss is purely temporary. It also makes the structural reforms which would have had to be carried out anyway considerably less painful both because the money borrowed comes at cheaper rates and because politicians are able to escape some of the blame for unpopular reforms by blaming the IMF. All too many politicians do that although the track record suggests that the most successful programmes are those in which the local political elite takes ownership of the reforms and embraces the necessary changes.

(This series will be concluded in a third article.)

[1]     Business Day, 15 May 2020.