Insights category - Markets economy
Markets & economy

Facing a fiscal crisis

The synchronised global economic expansion continues to gain momentum. World trade is growing and increasing demand is putting upward pressure on commodity prices. Normally, South Africa would benefit from these positive trends, but the best description of the present state of our economy is ‘stagnant’.

There was a rebound in economic growth in the second quarter. This was principally due to the agriculture sector’s strong recovery after last year’s drought and increased mining production. Domestic spending, however, remains weak. It seems that business investment plans are on hold until the outcome of the ANC conference in December becomes known. Given the positive global backdrop, an outcome which restores business confidence could see a stronger economic recovery next year.  A business-unfriendly outcome would probably have the opposite effect.

 South Africa is facing a fiscal crisis. Due to the stagnant economy, the growth in tax revenues has slowed at a time when fiscal spending is rising faster than planned, particularly because the government has been forced to bail out bankrupt state-owned enterprises. The fiscal deficit is heading towards 5% of GDP. It will be difficult to increase tax collections without a recovery in economic growth and to reduce spending is politically challenging.

The rising deficit will require significantly increased borrowing. It will be difficult to fund this without improved investor confidence and a credible plan as to how, in the longer term, a more sustainable fiscal balance will be achieved. The prospect that the South African government’s domestic credit rating will be downgraded to sub-investment grade further complicates matters. The outcome of this fiscal dilemma is critically important to investors in South African bonds and equities.

The global investment flow into emerging market interest-bearing assets continues unabated. South Africa remains a beneficiary of this phenomenon, despite the weak economy, a rising fiscal deficit and political uncertainty. For this reason, the rand has remained relatively stable and inflationary pressures have eased. Consumer price inflation was 4.8% in August. However, South Africa’s dependence on these fickle flows constitutes a major risk to financial stability.  Concerns about these risks were important in forming the decision of the South African Reserve Bank’s Monetary Policy Committee to leave interest rates unchanged at its September meeting.

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