Spending on current items such as public sector wages put at risk the roll-out of the government's infrastructure programme, economists have warned.
Shifting budgetary resources from current expenditure to capital expenditure was a major theme of Finance Minister Pravin Gordhan's February budget and last year's medium-term budget policy statement. But sustained increases in current expenditure, such as above-inflation increases for public sector workers, are "crowding out" capital expenditure, according to Dawie Roodt, chief economist at the Efficient Group.
He said with the ANC heading for its elective conference in December and the violent labour unrest in the mining and transport sectors, there was likely to be more political pressure on Gordhan and the treasury to maintain expansionary spending.
The presidency met representatives of business, labour and communities this week in an attempt to address the economic strife plaguing South Africa. Dennis George, trade union federation Fedusa's general secretary, said among the proposals on the table to address joblessness and ease tension was a motion to roll out aggressively the government's programme to build infrastructure.
Apart from the projects already planned or under way, progress on the infrastructure programme has been slow. Roodt said although large state-owned entities such as Eskom were responsible for the bulk of infrastructure investment at present, this had to be expanded much further.
He said the 7% increase granted to public sector workers, well above the 5% increase budgeted in February, was "not a train smash" in the short term, because there was time for consolidation given that South Africa's debt levels were still relatively low. But this fiscal policy was unsustainable in the long term.
It also revealed the difficulty the government was having in shifting the focus of its spending, Roodt said. "It's easier to spend money on salaries than build a bridge."
Although the treasury is expected to produce a medium-term budget policy statement with little surprises, there is some concern that the plans to reduce the budget deficit steadily will become more challenging.
In February the treasury projected the deficit would decline from 4.6% in 2012-2013 to 4% in 2013-2014 and to 3% in 2014-2015.
This is the line taken by ratings agencies Moody's and Standard & Poor's, both of which recently downgraded South Africa's credit rating and warned that further downgrades could be on the way. The Fitch rating agency is expected to follow suit.
In its ratings update, Standard & Poor's said the strikes in the mining sector were likely to feed into the political debate in the run-up to the 2014 elections, which could increase uncertainty over the ANC's future policy framework.
"We also expect that South Africa's underlying social tensions will increase spending pressures and reduce fiscal flexibility for the government," it said.
Because of production losses, the agency expected gross domestic product growth to reach no more than 2.5% in 2012 and 3% in 2012, whereas the current account deficit was expected to increase to at least 5.1% of GDP.
Moody's said a key driver for its downgrade was "the reduced room for manoeuvre for counter-cyclical macroeconomic policy in light of the persistent deterioration in the government debt metrics over the past four years, as the rise in the wage bill and debt servicing costs reduces the amount of resources available for development spending".
Government debt levels were about 40% of GDP, Moody's stated, and the fiscal space that had been created before the global crisis had largely dissipated. Although the government was attempting to stabilise the debt-to-GDP ratio, the recent wage agreement with public sector workers rendered these plans "more challenging".
But the treasury said in its response to the Standard & Poor's downgrade that the state's fiscal plan was "realistic and achievable. There is no historical evidence to support the agency's assertion that 'underlying social tensions [will] increase government spending pressure'."
It said South Africa had seen several elections in both the ruling party and the government, none of which had an impact impact on policy and budgeting in the manner that Standard & Poor's suggested.
The government would continue to invest in infrastructure to enhance the productive capacity of the economy and competitiveness of local industries, it stated.
In a research note this week, Investec economist Annabel Bishop said it was critical that government expenditure be "reined in".
"Should South Africa's Standard & Poor's rating fall again, there will likely be increased foreign selling of South African sovereign debt and thus substantial rand weakness," she said. "Wastage and inefficiency must now cease across all spheres of government and there must be recognition among all civil servants, from the president's office down, that money is tight and can no longer be squandered on luxuries and profligacy.
"A start would be urgent changes to the ministerial handbook to prevent further spend of tax revenues on new luxury motor vehicles for civil servants and luxury residential dwellings as these cannot be afforded. If South Africa loses its investment-grade status, it will lose the ability to borrow at reasonable costs."
It was imperative that the public sector and political leaders heeded the ratings agencies' warning, she said. "If not, Standard & Poor's will drop South Africa's rating below investment grade, which means it will cost considerably more to borrow. This is imperative as South Africa is borrowing to fund infrastructure investment, that is, future economic growth, because there is not enough tax revenue to pay for the multiplying social welfare needs."
Wikus Furstenberg, portfolio manager at Futuregrowth Asset Management, said although spending on infrastructure was being maintained at state-owned enterprises such as Eskom and Sanral, a greater problem was infrastructure spending at local government and provincial level. That was thanks to long-standing and well-known capacity problems, which would not be resolved readily in the foreseeable future, he said.
It was difficult to quantify the impact of the labour unrest, he said, but it would be a surprise "if it did not affect investor sentiment".
This has possible implications for the sustainability of portfolio flows into the country, particularly the purchase of local bonds, which helps to finance South Africa's current account deficit.
The current account deficit, which increased to 6.4% of GDP in the first quarter of the year, was widening because of two factors, he said. Owing to trouble in the European Union, local exports to one of South Africa's largest trading regions were declining, whereas unrest in the mining sector was contributing to "supply-side problems".
The industry contributes about 5% of GDP and about half of the country's export earnings.
Furstenberg said because of foreign investors' global search for yields and South Africa's recent inclusion in the World Government Bond Index, there had not been a significant sell-off of local bonds yet. But current events called into question the "sustainability of those flows and the sustainability of the widening current account deficit," he said.
Rating will affect power loans
The state-owned power utility Eskom had its credit rating downgraded by Standard & Poor's on Wednesday. This was expected and in line with the ratings agency's downgrade of South Africa's sovereign credit rating last week, alongside that of Moody's.
"Although Eskom's credit rating remains investment grade with the support of government, the recent downgrades by Moody's and Standard & Poor's are a concern," the company said. "An investment-grade credit rating is critical to access the cost-effective funding needed to ensure that Eskom and the industry can invest in the electricity infrastructure South Africa needs."
Eskom is a critical player in South Africa's infrastructure roll-out plans. The company's R350-billion new build programme is the largest in the country and includes Medupi, Kusile and Ingula power stations.
Affordable financing is critical to the successful completion of the programme, which has only 77% of its financing in place.