South African Public Debt: Internal and External

The results of these studies contrasted more recent studies in terms of its effects on economic growth. I will be investigating several research papers, as well as analysis economic indicators and various other sources, in order to determine whether or not South Africa is heading into a depression as a result of this.Literature Review:When an economy is in distress, a country generally experiences a high budget deficit as government attempts to subsidize the economic downswing, increased poverty rates from low employment levels and retrenchments, in developing countries: a simultaneous increase in population levels as uneducated adolescents may incorrectly assume having children will either increase grants from government, or allow more family members to earn an income, adding fuel to the economic fire. When real income decreases, along with employment levels, consumers hold back savings and spend lend, they also find it more beneficial to invest their money as interest rates are high, instead of investing in capital projects. The problem begins when government cannot increase taxes, but faces a high deficit, and has no additional revenue sources.

They begin lending money through open market transactions internally or borrowing externally.Low levels of public debt are suggested to lead to economic growth. A statistical model explains that 1% increase in public debt; resulted in an increase of 0.8118% increase is economic growth. A possible explanation for this could be that the debt incurred by government is to be injected back into the economy in the form of productive, revenue-inducing projects. The revenue earned of projects or economic stimulation (subsidies reducing producer or agricultural costs, allowing price decreases of food, in line with consumer price decreases, production cost decreases allowing for increasing employment, with increasing income thus increased spending, need for output leading to money demand increasing. Associated with decreased interest rates and increased investment spending from a decrease in opportunity coast of saving and bond holding. This is the ideal result: where the money created within the economy allows for government to repay its debts and thus the debt is necessary for saving an economy.

However, this ideal long-term result is challenged by the non-linear U-shaped model, suggesting a non-linear relationship existing between public debt and economic growth: that is, up to a certain ‘threshold’, debt will result in positive growth, and beyond that, the economy will begin to fall, the general find is a threshold of 50-90% after which growth declines. Some studies find that there is no threshold present, and the results are not sensitive enough to conclude that there is. Krugman’s model explains that as debt increases, and investor risk compensation demand increases, the contractual value of the loan: the repayment amount, can be bigger than the actual value so countries can be incentivized to default on the loan rather than to repay it. This decreases both their credit rating and investor confidence, adding to the cost of future borrowing or jeopardizing the possibility as a whole.

There is also the aspect of dead-weight expenditure, where the revenue received leads to non-revenue inducing projects, such as for military or social customs purposes. In Western Asia, Jordan went through a period of two decades prior to 2015, relying heavily on public debt in order to stimulate their economy. The period of 2000-2015 were analyzed: specifically, from 2007-2005, the total Public Debt increased by 17.1% of its Gross Domestic Product (GDP) which correlated to a significant decrease in economic growth by 8.6%. [Appendix 1] it was also noted that there is an inverse relationship in this study, between GDP growth and Public Debt.

Furthermore, the governments budget was negatively affected after the 2008 economics crisis as their external debt increased. [Appendix 2]However, economic growth was not negatively affected by the increases in domestic growth, signaling that when borrowing internally, the resource re-distribution may not necessarily stimulate growth, but it doesn’t cause a decline.

GRAPH AND TABLE: SOUTH AFRICAN ECONOMIC INDICATORS AS A % OF GROSS DOMESTIC PRODUCT: Appendix 3+4.South Africa has a pattern on increasing external debt as a crisis hits. Around 2001-2003, there was a massive spike in external borrowing. During this time, South Africa was facing an economic distress. Again, in 2008, the global recession, external debt significantly increased, and has been increasing at a rapid rate since. The investment spending/Gross Capital formation decreased slightly and shows a negative relationship between the spikes in external debt and investment spending.

This relationship could either increasing external debt causing a decrease in investment spending, or, a decrease in investment spending results in a need for external debt, or when an economic downswing occurs, it effects one, the other or both, or these factors cause the economic recession.South Africa differs in one detrimental factor. In 2002, it was one of the largest infected HIVAIDS populations. This is related to Gross Domestic Product directly, as the country also relies heavily on agricultural, mining work and the transport sector. The engagement of workers within these environments causes further contagion of the disease.

The infection is causing a huge deadweight expenditure, as the human capital is less productive, or unable to work and other human aspects, as well as quantities effects of big demographic and labor market costs, worsening the economic activity, and resulting in government needing more funding for revenue producing projects to make up for the deadweight expenses.[OECD, 2002]The above depicts South Africa facing a debt trap: The debt to GDP ratio is increasing while both investment and savings remains at a general level, showing no signs of dramatic change. This indicates that South Africa is not injecting their borrowed funds in a productive manner. The VAT increase to 15% will give government an additional source of revenue, however this may just aid their debt payments, and not service the economy. Despite the economic conditions of all the BRICS countries, specifically Brazil and Russia, South Africa has the highest ratio of all of the BRICS countries and, the highest unemployment rate of all the European Union countries as of 2017, including Greece, the United Stated, and Japan.

These factors, as well as the corruption exposed in relation to Jacob Zuma, former president, the Gupta’s, as well as Pravin Gordhan being fired. The disorganized nature of the economy, with a depreciating currency, is not favorable for foreign investors. Their confidence was jeopardized and may take decades to fix. The skyrocket of foreign debt could be related to this increased investor risk premium and depreciated currency, causing the budget deficit to increase as interest rates increase on debt. If South Africa were to default, investor confidence and future lending could be dramatically damaged, possible permanently.[South African Market, May 2018]The Ricardian equivalence theory comes into play when looking at the savings and investment relationship to government deficits. This theory says that any change in government borrowing, will be offset by a simultaneous change in private saving, therefore government deficits might have no effect on investment directly. This is due to a deficit drop, causing lower interest rates and consumers find it more beneficial to hold liquidity, savings decreases, and when government deficit rises, interest rates rise and savings increases. The graph above shows this to be possible, which could mean that the state of the economy in terms of savings and investment, which are the main factors that stimulate economic growth, may be unaffected by external debt, and could not send the economy into a recession, directly.[Rice University, open textbook: Chapter 31.]External debt stocks (% of GDP): Apendix 5:In 2002, all 4 countries increased their external debt. This is in line with the global recession.

As these are all developing countries, this could be due to their internal borrowing through taxes suffering if they were to increase taxation. In addition to this, public borrowing internally would be scarce in a declining economy, especially as government fragility or chance of default is high. Government would need to receive funds from first world foreign debtors. Thus external debt would grow in all 4, whereas in a first world country, their external debt may not be as detrimental as they would generally be able to afford the consequences afterwards relative to developing countries. Ghana experienced a highly significant decline in external debt following the recession, as the economies recovered, and then stabilized at the next economic downswing in 2008. Kenya showed similar patterns, in a far less extreme manner, and Botswana and South Africa seem to have had similar patterns, up until the beginning of the recent economic distress and foreign investors confidence decreasing from 2014, where they have a more inverse relationship, as Botswana seems to be borrowing less external revenue, and South Africa and Ghana borrowing more. Kenyan seems to be about to decrease their external debt, however their pattern is not predictable. An interesting find is that taxation increases that can be as a result of increased interest payment are associated with more reliable borrowers. From the 1998 lead up to the global recession, taxation rates increased from 4% and kept increasing to 2006 to 14% in resource extraction. The negative effects of a tax increase may seem harsh, however, the recovery of these countries from the recession seemed to have been far greater than those that kept low taxation rates and relied more heavily on revenue on oil or mining. Kenya is one of these countries.

South Africa has just increased taxation to 15%, this could potentially help the economy, as an increase seems harmful in the short-run, but may be necessary in the long run as seen in Kenya, especially in restoring confidence in foreign investors and credit rating.Botswana was put in a positive light as “David Cowan at Citi suggests that sovereign debt borrowers could learn from Botswana”. Botswana carefully evaluates each and every project to be undertaken, and continues with it only if the benefits exceed the costs. The correct planning, educated leadership and skills are crucial in order to do this properly. Botswana seems to suggest that this is the way in which debt could positively affect economic growth, as they understand debt and spending are not the equivalent as development. Ghana’s rapid debt decrease was the result of a 3-year support program agreement with the International Monetary Fund. The investment and economic growth increased significantly as they relaxed their free trade barriers, and eliminated price controls. The loan received from the International Monetary fund helped their economy grow, and their government deficit decrease. Interestingly, South Africa has not requested help from the IMF, and with the debt increasing rapidly, and growth declines. Some skeptics say that asking the IMF for help is recipe for disaster, that the government will purely base the countries situation on financial blame and increasing revenue earning projects, and ignore the underlying issues needing to be addressed. [Mutixe, M. Aug 2017]South Africa seems to be facing a detrimental future. The economy is declining and external debt is rising.

The government is politically distracted and have recently faced corruption and questioned leadership. The country is not only declining financially, but also qualitatively, the social and non-monetary aspects are also showing negative progress. Strikes, educational gaps, political parties focusing on their position in term of elections, HIV and many others are all facing distress. The credit rating and foreign investment confidence plummeted following Pravins dismissal. The increase in taxation could be a savior in the long-term, but without the underlying issues of the skills, sensitive analysis needed in conducting cost benefit analysis, corruption and qualitative factors, the country could be facing an oncoming depression.Therefore, an increasing government debt that is the result of investment in the unrealistic salaries of a bloated government workforce, funding corruption and unaccounted expenditure can be one of the causes of an economic downturn. Conversely an increasing government debt that is the result of investment in needed infrastructure, education and skills development, incentives to entrepreneurs, manufacturers and farmers can be good for an economy. In conclusion, the simple answer to the question “will SA’s increasing government debt lead to a depression” is, No. Although it is strongly correlated with economic distress, the need for external debt arises when a country is unable to fund their own development.