Debt is our destiny: How government is spending us into crisis
Tuesday, May 19th, 2015
By Gerhard van Onselen and Piet le Roux: Solidarity Research Institute
Medium-term forecasts foresee national debt increasing by approximately 31% from R1,8 trillion in 2014/15 to R2,3 trillion in 2017/18. Moving from a debt to GDP ratio of 31,6% in 2009/10 to 46,2% in 2014/15, government finances in South Africa are triggering all sorts of alerts at international credit agencies. In this article we take a look at some of these debt numbers, arguing that the situation is likely to become direr.
Growing at 19,2% annually since 2008/09, South Africa’s gross national debt has seen a steady increase over the past six years. Spending increased by 10,1% per year, but at a growth rate of 7,7% revenue did not follow suit. In the graph below, the sharp increase in government debt from 2009 onward is evident.
Where did the debt come from?
While the sub-prime mortgage crisis in the USA and the government debt crisis in Europe undoubtedly played a major role since 2008 in dampening revenue and increasing government spending in South Africa, it also drove the emerging market bond boom and made extraordinarily low-cost borrowing possible to South Africa. After having built up a habit of overspending under the then Minister of Finance, Trevor Manuel, it was never going to be easy for the government to commit to some real reductions in expenditure, and nothing of the sort happened.
The Pravin Gordhan years saw a dramatic decline in revenue growth, but for all the regular talk of limits on luxury spending by ministers and tightening of the catering belts, government spending maintained course for the stars.
In February 2015, amid much debate on the merits of austerity, Minister Nhlanhla Nene delivered his first budget speech. Judging by his budget, Minister Nene agreed that austerity was a good thing … austerity for Joe Taxpayer, that is. To finance yet another government budget significantly larger than that of the previous year – and growing interest payments – Nene announced the first explicit income tax increases in years.
There is a reason Nene did not meaningfully alter course. On the back of a very narrow tax base and fragile economy, the South African government has now long been committed to appeasing a restless population with welfare grants and over-paid civil service jobs. In addition, state policies are manifestly anti-business and by government’s own account the state sector is plagued by corruption. These sharp features of local politics show no signs of subsiding. South African government finance then remains defined by severe pressure for ever higher spending and an increasingly hamstrung private sector. In short: the spending won’t stop, but the income will. Debt is our destiny.
Budget deficit: feeding the debt
Government’s budget deficit has seen a major expansion since the financial crisis of the late 2000s. Fiscal deficits translate directly into greater government borrowing requirements. In nominal terms, the combined net borrowing requirement over the five-year period 2004/05 to 2008/09 was R16,1 billion. This figure jumped to R694,3 billion for the five-year period 2009/10 to 2013/14. Without marked increases in revenue, of which there are no signs on the horizon, or marked decreases in spending, of which the signs are even less, government debt is set to increase.
Impending maturities: the structure of state debt
The great bulk of government debt is held in the form of ‘marketable domestic government bonds’. These bonds are sold mainly to institutional investors and represent a contractual right of a lender to receive regular interest payments and the repayment of a face value amount at a future maturity date, ranging up to 35 years. Marketable domestic bonds currently make up R1,4 trillion (78%) of state debt. The current maturity structure of domestic bonds, in context of a wide fiscal deficit, suggests that more borrowing will have to be undertaken to refinance older maturing bonds.
Most government bonds require large once-off payments of a capital sum at maturity, instead of capital being paid over the term of the loan. A cluster of bonds maturing close to each other increases capital repayment risk, where insufficient funds may be available to repay outstanding bonds. This risk is especially pronounced during conditions of a national budget deficit. It is therefore not surprising that the 2015 Budget Review notes maturity profile and refinancing risk when it announces three new bonds.
During 2015, three new bonds will be issued. These instruments will broaden funding options, help to smooth the maturity profile of government debt and reduce short-term refinancing risk.
Debt servicing costs
More debt means higher debt servicing costs. Even in an environment of low interest rates, mounting debt can become expensive to service. The South African government’s borrowing costs grew steeply in nominal terms since 2009 and is estimated to reach R153 billion in 2017/18, which is 12,1% of projected revenue. While effective annual interest rates may be relatively low at present, interest is now payable on more total debt. An increase in interest rates poses a risk for even higher future debt service costs on new borrowings. In such a case debt servicing costs are likely to expand even faster above annual increases in revenue. The nominal increases in debt service cost are reflected in the following graph.
A declining revenue stream
Under normal conditions state debt and interest is serviced from tax revenues and mild currency inflation. Since 2009 gross government debt and expenditure has been growing at a rate faster than tax revenues. Sufficient cash flow from tax revenue is required to service state debts. Depressed revenues lower a government’s ability to service its debts. When revenues relative to the cost of debt servicing reach critically low proportions, a national debt crisis is on hand. The chart below illustrates the growth in gross debt against revenues.
The great rollover
A debt maturity profile represents the amounts outstanding and different dates at which individual debts in a portfolio matures. The figure below illustrates the maturities of all the marketable domestic bonds issued by the South African government as at 31 December 2014. The highlighted area on the graph depicts the number of bonds that will reach maturity in the next ten financial years. Over the next five financial years R332,5 billion in domestic bonds are set to mature, followed by R280,7 billion in the next five consecutive years. This is 38% of marketable domestic debt.
Owing to persistent economic and fiscal difficulties, much of government’s debt is likely to require refinancing under unfavourable future conditions and lower credit ratings. Lower ratings usually increase debt service costs, which will make escaping an existing debt spiral even more difficult. A weak economy, lambasted private sector, narrow tax base and a virtual impossibility of lower state expenditure precludes any real reduction in state debts.
Debt rollovers cannot persist indefinitely. There are only three realistic routes for the settlement of state debt. The first is paying capital and interest from tax revenues, the second is eroding real debts by currency inflation (a “stealth default”) and the third is outright default or debt restructuring. The generation of cash through the sale of state assets is another option, but that avenue is rarely deliberately followed and, although mooted by Nene, unlikely. For us, mounting debt then is a reality that means higher taxes, inflation or crisis.