4 scenarios for South Africa’s economy

 ·26 Aug 2022

A new report by the Organisation for Economic Co-operation and Development outlines four scenarios for South Africa’s economy and the handling of public debt following the Covid-19 pandemic.

The scenarios form part of the group’s wider analysis of the post-Covid state of the country, which calls for an overhaul of the tax regime to fund economic-growth enhancing reforms and reduce inequality.

The key reason for this is that the economy, it said, has reached the limits of budget adjustments that were aimed at reducing fiscal deficits and reining in debt.

The Covid pandemic saw the government budget R500 billion to support businesses and the public at large during the pandemic. While these measures were commendable and much needed, they had the effect of pushing the country’s debt a lot higher.

South Africa’s public debt to GDP ratio skyrocketed in 2020 in the wake of the Covid-19 pandemic, like many other global economies. The cost of servicing this debt remains a significant burden on the fiscus, representing 4.3% of GDP and around 17.3 of total government revenue.

The OECD said that the government now needs to work in a post-Covid framework to bring this debt under control. “South Africa needs higher growth and a fiscal reform to stabilise its debt to GDP ratio,” it said.

It presented the following scenarios on how the country could move forward through to 2050.


Worst-case scenario – do nothing

In the worst-case scenario, debt would continue to rise progressively as in the last decade, the OECD said. This is the baseline scenario.

This happens in the context of the government’s contingent liabilities representing 20% of GDP in 2021. The scenario extends the short-run economic outlook for the country, with a growth rate of 1.5% from 2024 and a gradual improvement of the primary balance to 0.5% of GDP from 2023.

In this scenario, fiscal sustainability might be at stake in the South African context of low growth and high borrowing rates.


Structural reform scenario

The structural reform scenario assumes that the government is able to effectively and efficiently implement policy changes that stimulate growth and are able to bring in more revenue.

This includes addressing the electricity crisis and overhauling the tax regime. Some changes proposed include taxing the wealthiest more, or raising VAT.

The structural reform scenario boosts GDP growth to 2.5% from 2024.


Spending control scenario

The spending control scenario assumes that the government is able to successfully reprioritise its budget and stick to it, not leaving room for deviations.

It includes not buckling to higher wage demands and also steering away from more bailouts to State Owned Enterprises (SOEs). Budget would be directed to projects, initiatives and projects that grow the economy.

The scenario combines a primary surplus of 1% of GDP from 2022 with the baseline scenario.


Best-case scenario – complete reform

In the best-case scenario – which includes both structural and tax reforms – increased government revenues help finance infrastructure investment and policy reforms while contributing to the doubling of the primary surplus.

In this case, the country’s debt to GDP ratio will start declining progressively from 2025, the OECD said.

The complete reform scenario takes into account the effects of implementing structural reforms that would increase potential growth to 2.5% from 2024 and tax reform that would increase the primary surplus to 1% of GDP from 2024.

To ensure fiscal sustainability would require measures to curtail SOE bailouts, raise revenue and improve the efficiency of public spending, the OECD said.


Problems

The government may have reached its limits of spending reprioritisation, the OECD said, which would make the best-case scenario difficult.

“The government’s fiscal strategy rests on improving the composition of spending by reducing wage compensation growth while protecting capital investment.

“Almost half the reduction in spending comes from cutting the wage bill, which represented 34% of government spending in 2020. Government wages have been increasing by an average of 11% over the last decade,” it said.

While the government initiated a wage freeze in 2020, which has kept spending stable at 31.5% of total spending, this aspect is coming under increasing pressure, with workers demanding more and threatening strike action.

But even if the wage bill freeze stays in place, the OECD said that spending pressures remain elevated, particularly with high levels of need in the higher education, water and electricity space.

“Without a strong and sustained recovery, South Africa risks losing some of its hard-earned social progress in areas like education, housing, welfare and healthcare,” OECD acting chief economist Álvaro Pereira said.

“Strengthening public finances, creating a more growth-friendly tax system and fostering higher productivity through enhanced infrastructure, education and competition and more reliable power supply will be key to get the recovery back on track and ensure higher living standards.”


Read: Call for South Africa to overhaul its tax system, including a VAT hike

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