Negative to Stable outlook? Does it matter?

 The Relevance of the Negative to Stable outlook.

14 April 2022. 

By: Abongile Vika

“Main contributor to the stable outlook is

the improvement in South Africa’s fiscal position which led to

 a higher likelihood of debt stabilization.” 

One of the two most crucial areas for the government has been to improve our fiscal position through debt stabilization and to accelerate economic growth. The one that we can see some level of progress in is debt stabilization. However, this should not be seen as a big win as the economy is still faced with very large risks. Addressing the structural constraints in SA’s economy to accelerate economic growth will take more time than we would hope but this does not mean we should not point to some small positive signs that we might be moving in the right direction even though in reality this will not make much of a difference in the day-to-day lives of South Africans.  

Before Covid and During Covid:

We were in a low growth/high debt equilibrium. We would take out debt, however, due to structural constraints such as an unstable electricity supply, labor market rigidity & low productivity, we had low growth hence we weren't generating enough revenue to maintain this debt. One of the major concerns from development institutions and credit rating agencies was that we were heading towards a credit default. Some might argue that we were not seriously close to this default but in such situations, it is obviously advisable to be overly cautious as the consequences are often highly detrimental and in a country with one of the highest levels of poverty, unemployment, and inequality, I would have to agree with the heightened sense of alarm. The figure below illustrates our position

Why Stable?

The main contributors to the stable outlook can be broken down into internal and external factors. The internal factor is the government’s fiscal consolidation strategy that it has been pursuing for the last couple of years. The main external contributor is the commodity price boom. The higher commodity prices have increased profit levels for mining companies leading to a 58% increase in corporate income tax in government revenue or 2% of GDP (Moody’s, 2022). One of the main contributors to the internal factors was the governments’ ability to limit the growth of its wage bill to only 1.6%, which is below the inflation rate. These two factors were the main reasons why the government was able to reduce its primary deficit to 1.3% of GDP in FY2021 from the 5.7% (Moody’s, 2022). It is important to note that the reduction was lower than Moody’s own predictions of 3.4% of GDP. Moodys has also highlighted that it expects the government to continue with its fiscal consolidation strategy and has also noted that there is a considerable effort to rebuild the South African Revenue Services’ institutional capacity which could have positive effects on the governments' ability to collect revenue.

Going Forward?

From my perspective, it would seem that the governments' plan is to control its debt through direct actions such as the reduction of the wage bill but also indirectly tackle the debt problem by increasing revenue. It is my belief that the government should continue with its fiscal consolidation strategy but should also intensify efforts to accelerate economic growth. In my view, we can manage our debt better by increasing the revenue that we are taking in. In a recent study, it was suggested that with inflation at 3%, growth of 1%, and the nominal cost of debt remaining at current levels then we would need a primary surplus of 2% of GDP to stabilize the debt. With the growth of 3% and everything else the same, then we would need a primary surplus of 1% of GDP to stabilize the debt. At 3% growth, then we would need a primary surplus of 0% of GDP to stabilize the debt. This shows that there is clearly a strong correlation between economic growth and debt sustainability. 

Moodys has noted that South Africa is at a heightened risk of social risk due to the low growth and labor market rigidities that increase inequality and poverty. They further emphasize that the unstable electricity supply is a major factor in low growth. It is simply not possible to have constant economic growth without the energy to power it, however, in this regard, the government has notified us of its plans to address this problem. For example, one of the main government solutions is to improve the efficiency and effectiveness of the network industries (Eskom & Transet) in order to boost economic growth through an increase in productivity for the economy but the main point is to see if they can actually implement this. Moodys has further highlighted that an upgrade is more likely when real progress is seen in addressing the growth constraints but also noted that a downgrade is also possible if growth prospects deteriorate and we weaken our fiscal position.   

It is important to note that the main reason why Moody’s changed the outlook from negative to stable is that they see some effort from the government. However, it is also equally important to realize that we have not been upgraded due to the structural growth constraints that have been holding us back for a long time. The commodity price boom will not last forever, but it did show the importance of increasing growth as a form of debt stabilization, which I believe is the more crucial strategy for a country like South Africa. Debt by itself is not the problem but what is achieved with the debt is very important. Using debt in a way that creates more jobs and accelerates growth will ensure that we reduce poverty and inequality levels but would also mean we are able to pay back the money that we are borrowing at a more affordable rate. 

This blog post was based on information obtained from: 

https://www.moodys.com/research/Moodys-downgrades-South-Africas-ratings-to-Ba2-maintains-negative-outlook--PR_436182

https://www.wider.unu.edu/publication/macroeconomic-risks-after-decade-microeconomic-turbulence 

 

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