PETER ATTARD MONTALTO: A scythe to the fiscal mania

The moving of the medium-term budget policy statement to November 1 allows more time for more mania. As usual, people will miss the difference between temporary and permanent fiscal shocks and that each needs different solutions.

The market and media seemed to lose its head on Friday at a throwaway comment from an analyst that there was “perhaps” the need for a VAT hike — ignoring that tax hikes are never announced at a medium-term budget. While the National Treasury could theoretically pencil one in from April without announcing it now, it is politically impossible before elections.

The context of the run-up to this medium-term budget is the revenue “shock” (undercollection of about R59bn) and the intrayear cuts that the Treasury has started expenditure guidance circulars.

The wider issue is whether there is a fiscal crisis. No, Treasury isn’t about to run out of cash and the entire show isn’t about to come crashing down. The Treasury and markets take a medium-term view of sustainability. Budgets, broad fiscal planning and the budgeting process are a multiyear affair and the medium-term budget is about setting the three-year outlook for spending against expected revenue and debt capacity. While reforms are likely to yield a wider tax base and faster growth eventually, it is unlikely to show in the coming three years and, so, combined with the need to revise down prior revenue projections, the bar is much lower.

The Treasury knows that it takes time to turn the fiscal ship when steadily rising debt service costs (which we see rising from 3.6% of GDP in 2019-20 to 5.5% in 2025-26), SOE bailouts and other facts continue to weigh on the fiscus. We are clearly headed in the wrong direction considering realistic revenue, and the course needs to be corrected.

It’s no good wishing it were higher through actions that won’t be taken (such as cutting interest rates to speed up growth) or instituting taxes that won’t be done in time (such as a wealth tax, which would take many years to enact according to Sars and the Treasury).


Steepest curve


The problem is the view that there is no such thing as a fiscal cliff because you can also print money, issue debt or raise taxes. That is true, but the point is that there are deep, problematic consequences to those routes.

While there is a yield for anything, SA’s yield curve is one of the steepest among its peers and is showing up the problems of existing issuance levels let alone some big step up. Moreover, the functioning of the bond market has remained weak post-Covid, with bid-offer spreads (the gap between the yield at which you can buy or sell bonds) remaining wide at four basis points (bps) on average this year, compared with an average two bps prepandemic. That has occurred as foreigners have steadily left the market.

So you could add R100bn borrowing to the market a year (raising weekly issuance from R3.9bn to R6bn) to pay for whatever, but the impact on yields would be punishing. More importantly, as the entire interest rate structure in the economy would rise on such a move the Reserve Bank would hike rates further and banks would stop lending to individuals and businesses, and simply buy bonds. That is called crowding out and shows the fiscal dominance of monetary policy.

Appeals to prescribed assets and the PIC taking more bonds at lower interest rates are pie in the sky. Outfits such as the Institute for Economic Justice (IEJ) that make these calls should actually talk to workers and their unions that sit in the Government Employees Pension Fund (GEPF) directing investment mandates. They will very soon be told where to get off when seeking to fiddle with people’s pensions.

The reality is the market is extremely delicate. The Treasury is already trying to shift strategy with this week’s issuance of sukuk (Sharia-compliant bond-like instruments used in Islamic finance) to tap wider sources of funding, and bringing the usual bond issuance duration lower on average. But asset managers want ultralong paper and so this strategy is progressing exceptionally slowly while yields on the middle part of the curve have thus risen quicker than the long end in recent months.


Magic money


The idea of magic money is fantasy. The Reserve Bank will not embrace modern monetary theory under its current or next governor and start buying bonds for fiscal space reasons (as opposed to market liquidity backstopping, which it did during Covid-19).

The IEJ and SACP claim to have found a new pot of magic money: the gold and foreign exchange contingency reserve account that apparently no-one had ever heard of — which sat with the Reserve Bank at about R459bn at end of July. Suddenly all problems are solved!

There seems to be a lack of understanding what that account actually is. First, it’s not a pot of cash. It can’t just be tapped like a bank account; it’s a technical balance sheet liability the Reserve Bank has to the Treasury.

It also isn’t “owed” to the Treasury in the normal sense, because it results from the Reserve Bank holding certain other assets on behalf of the Treasury, in particular forex reserves that under the Reserve Bank Act then have unrealised gains that are booked into this account. Drawing down these balances would require the sale of forex reserves, yet the IMF believes SA’s reserves are on the low side of adequate so that isn’t an option. As they are unrealised gains the account is volatile in size and so most of it could never be tapped.

There are other complex ways of the Treasury calling on parts of this liability without selling forex reserves but those would involve complex operations that would result in a significant cost for the Reserve Bank (or Treasury) and would have to end up being paid somewhere in the system. That imposes a significant bar on the cost-benefit calculation of its use.


Plug shifts


The amusing thing about being liberally quoted in an IEJ report is to point out the bits they missed. We said explicitly in the report they cite (which was designed for markets that have been discussing this issue for at least four months now) we don’t think the gold and foreign exchange contingency reserve account can or will be used in the short run given the wider negative consequences of tapping it would outweigh any positives, as well as the technical difficulties of structuring access.

If it is used in the long run, it would not be to plug structural shifts in spending or revenue shocks we are seeing now. Much of the fiscal mania is about acting as if there is a crisis by recommending a short-term run and temporary means to plug structural gaps. Only a portion of the contingency reserve account would and should be used only for one-off credible spending such as large expensive debt redemptions (not for SOE bailouts). And then only if a credible fiscal rule is in place that keeps the underlying fiscus on a sustainable path and in which appropriate coverage of the costs of using the funds is guaranteed.

Apart from that, many of the IEJ’s proposals are marvellously Washington Consensus and neoliberal! The call for expenditure prioritisation and the application of expenditure reviews is exactly what markets and business have been calling for, for years. The same is true for more Sars funding and state consolidation.

The mania will no doubt continue but we must keep an eye on what is feasible and practical — being mindful of what is structural and what is temporary. That is exactly why hard choices lie ahead when there are no free lunches.


Peter Attard Montalto leads on political economy, markets and the just energy transition at Krutham.

This article first appeared in Business Day.