Fiscal Space Profiles of Countries in Eastern and Southern Africa. Case Study South Africa Fiscal Space Analysis

Transcription

1 Fiscal Space Profiles of Countries in Eastern and Southern Africa Case Study South Africa Fiscal Space Analysis June 2017

2

3 Table of Contents Table of Contents 3 List of abbreviations 5 Preface 7 Executive Summary 8 1 Introduction 11 2 Characteristics of the specific country situation 15 3 Description of the model and data compilation 21 4 Analysis of data on recent priority expenditure and its underlying financing flows Education expenditure Health expenditure Social assistance expenditure Social welfare expenditure Fiscal space 31 5 Options to enhance fiscal space Tax and non-tax revenue External grants Non-priority expenditure External-debt service External debt disbursements Net internal borrowing Concluding remarks 40 6 Formulation of different scenarios: exercise 41 7 Conclusions 47 8 References 49 Appendix 1: Fiscal space s 51 Appendix 2: List of Interviewees 64

4

5 List of abbreviations AIDS CIT CPI DBE DJCD DHET DPME DoH DSD ECD ENE EU FFC FSA GDP HIV MTBPS MTEF MTSF NDoH NDP NGOs NHI NSNP OECD PIT SARS USAID UNICEF VAT Acquired Immune Deficiency Syndrome Company Income Tax Consumer Price Index Department of Basic Education Department of Justice and Constitutional Development Department of Higher Education Department of Planning, Monitoring and Evaluation Department of Health Department of Social Development Early Childhood Development Estimates of National Expenditure European Union Fiscal and Financial Commission Fiscal Space Analysis Gross Domestic Product Human Immunodeficiency Virus Medium Term Budget Policy Statement Medium Term Expenditure Framework Medium-Term Strategic Framework National Department of Health National Development Plan Non-Governmental Organisations National Health Insurance National Schools Nutrition Programme Organisation for Economic Co-operation and Development Personal Income Tax South African Revenue Service United States Agency for International Development United Nations Children s Fund Value Added Tax 5

6

7 Preface This report is part of a series of country studies carried out by Ecorys and associates for UNICEF in Eastern and Southern Africa. The project aims to strengthen UNICEF s advocacy efforts through a better understanding of the role of political economy factors in processes and decisions around the creation and use of fiscal space for investments in children. This report was written by Fouché Venter and Kemedi Kgaphola of DNA Economics. The writers of this report wish to thank the staff from UNICEF South Africa for their support and guidance. They also express gratitude to the various government officials and other stakeholders who provided inputs. The findings, interpretations and conclusions expressed in this report are those of the authors and do not necessarily reflect the policies or views of UNICEF or of the United Nations. The text has not been edited to official publication standards, and UNICEF accepts no responsibility for errors. The designations in this publication do not imply an opinion on legal status of any country or territory, or of its authorities, or the delimitation of frontiers. 7

8 Executive Summary Sluggish economic growth, high inflation and rising debt servicing costs make expanding fiscal space for priority sectors very challenging in South Africa. Following the global financial crisis in 2008, low commodity prices, electricity shortages, and more recently, severe drought and political uncertainty have contributed to South Africa s slow economic recovery. The National Treasury is also trying to reverse growing public debt levels, which inhibits the potential for a large fiscal deficit, while also tightening the money supply to stave off inflationary trends. These moves are extremely crucial as ratings agencies downgraded South Africa s foreign currency denominated debt. South Africa s government has remained committed to increasing spending on priority sectors defined as education, healthcare and social development but funding needs are expected to quickly rise. Education spending has been on the uptick. Yet, the school system has created significant wastage, e.g. many provinces employ more teachers than they can afford, while there is a strong mandate from the new government to invest more in infrastructure. Along with the country s move toward a single-payer, state-financed healthcare system, investments in healthcare services has also increased in recent years. However, state-finance healthcare, coupled with the current disease burden and shortage of health professionals, means that the demand for funding is rapidly escalating. In terms of social development, child-related grants as well as expenditure on children and families, especially at the provincial level, have increased substantially over the past five years. Nonetheless, persisting inequalities, needs and spending inefficiencies highlight the need for more and better social development spending. In a baseline status-quo scenario where economic growth is in line with recent trends, increasing spending on priority sectors based on projected needs will lead to a fiscal-space financing gap. Over the next five years (FY2016/17-FY2020/21), the overall priority expenditure is estimated to be 11.1% of GDP, on average, which amounts to R23,139 (or US$1,689) in per child terms (at FY2015/16 prices and exchange rate). Given that external financing options will be few and costly, the gap will need to be bridged via internal financing, which is estimated at 1.5% of GDP. One option to increase fiscal space for priority expenditure is to increase tax rates on specific goods. Current tax proposals include increasing the fuel levy, the transfer duty on property sales and capital gains tax rates, as well as increasing or introducing sin taxes, including increasing excise duties on alcohol and tobacco products and implementing a tax on sugarsweetened beverages. These tax proposals are expected to add approximately R11.6 billion to the coffers each year. After factoring in income tax relief for low income earners, this would create roughly R5.9 billion to the expected revenue in 2016/17. If all of this additional revenue is allocated to priority expenditure, spending on priority sectors would increase by approximately 1.4%. Debt consolidation is another option that could create opportunities for increasing spending on priority sectors. In its attempt to consolidate debt, South Africa plans to grow revenues at a faster rate than expenditure. The slower growth in expenditure is planned to be achieved through cuts in compensation budgets, budgets for non-essential goods and services, and program budgets 8

9 that have a history of underspending. The saving from budget cuts in non-priority areas could be used to offset the deficit or be redistributed elsewhere. If strong value for money arguments and sound financial management practices can be demonstrated, priority sectors could benefit through budget reprioritization processes. It remains clear that the most viable option to expand fiscal space over the medium term is a quick return to strong economic growth. Historical data confirm that revenue from South Africa s primary tax instruments (e.g. VAT) will rise substantially even if GDP growth recovers only slightly. This is especially true if GDP growth is driven by improvements in private sector industries as global economic conditions improve. Based on a high debt-to-gdp ratio and the recent downgrades by the major credit rating agencies, increasing debt disbursements is a less viable option to boost spending on priority sectors. It is generally not advisable to use commercial external debt to fund education, health or social protection expenditure, as yields from these investments are only reaped over the long term, which extend far beyond the typical repayment terms (usually ten years for these arrangements). Moreover, as earlier mentioned, South Africa s foreign currency denominated debt was recently downgraded, which limits the opportunities of new external financing sources and significantly increases borrowing costs. The current situation thus makes new debt an ill-advised avenue. Despite the challenges presented by a negative economic outlook and mounting debt, South Africa has options to continue its commitment to boosting spending on sectors that matter for children. Indeed, the demand for funding for the education, health and social development sectors is rapidly growing in response to needs, population changes and new government priorities. And there are several strong opportunities that can allow the government to effectively address this demand. These include increasing tax rates, reallocating resources from other areas and fostering broad-based economic growth, all of which can go a long way to address the fiscal gap and improve the lives of children across the country. 9

10

11 1 Introduction This report describes an analysis of the South African government s recent and future financial capacity to utilise expenditure that children depend on for their human development and general welfare. This financial capacity is understood to be the fiscal space for identified priority expenditure for children. The fiscal-space analysis has been carried out using a fiscal- exercise in Excel (SAFS.xlsm). Although this report reviews various scenarios, it does not recommend and specific options for the creation of fiscal space. The scenarios are primarily presented for illustrative purposes. This chapter refers to expenditure regarded as beneficial to children as priority expenditure. For South Africa, priority expenditure comprises the following expenditure categories: 1 Education: Includes all expenditure incurred by Provincial Departments of Education, National Department of Basic Education and expenditure incurred by the Department of Higher Education on the training of teachers; 2 Health 1 : Includes all expenditure incurred by the National Department of Health and Provincial Departments of Health; 3 Social assistance: Includes expenditure by the National Department of Social Development on the Foster Care, Care Dependency and Child Support Grant 2 ; 4 Child welfare: At national level, child welfare expenditure includes all expenditure by the Children, Families and Youth sub-programmes within the Welfare Services, Policy Development and Implementation Support Programme 3. At provincial level, we have included all expenditure by the Children and Families Programme. The composition of the government expenditure defined as priority is inevitably somewhat arbitrary. Government expenditure classified as non-priority includes some expenditure that does in fact matter for children s welfare. Most notably is child protection services provided by the South African Police Service (SAPS) and the Department of Justice and Constitutional Development. Although the expenditure is important, it is not possible to isolate the expenditure in these areas as expenditure is generally not recorded and tracked at such a disaggregated level. In contrast, expenditure classified as priority includes aspects that are unrelated, or only loosely related, to children s welfare. This is especially true for expenditure in the health sector as it was not possible to isolate the expenditure that primarily benefits children. This is important to bear in mind when considering when advocating for shifts away from non-priority expenditure to increase priority expenditure. Future analyses of this kind may work with different definitions of priority expenditure. The methodological approach this paper describes could be applied in the same way, but would be dependent upon access to the data in the disaggregated format required. It is also important to bear in mind that the fiscal space discussion concerns only the expenditure carried out by the government within its budget. Government expenditure on education and health plainly constitutes the bulk of the resources dedicated to education and health in South Africa. Nevertheless, non-governmental expenditure in these sectors is also significant. In particular, 1 Although other departments also incur expenditure on health care, this expenditure is very difficult to isolate. The expenditure by these departments in which this expenditure is incurred is also generally not within the definition of priorityexpenditure for the purposes of this report. 2 The respective purposes of these grants are explained in section National and provincial departments are divided into programmes according to specific function and purpose. These programmes can therefore be thought of as department within departments. 11

12 international agencies and many non-government entities provide substantial resources to these sectors outside the government budget. One especially important example of education expenditure that mattered crucially for children s welfare was the European Union s funding for the Primary Education Sector Policy Support Programme of R1.3 Billion over 5 years. This funding has provided resources kits, workbooks, teacher training, toolkits, ICT and media resources and study guides 4. In the health sector, the European Union has also funded support for the re-engineering of the South African Primary Health Care Sector to the value of approximately R1.1 Billion over the between 2012 and This primary health care programme is important for children (more detail is provided in the report). The present focus is on government expenditure in the priority sectors that flow through South Africa s fiscal accounts 6. This report provides an overview of the analysis of the recent and prospective performance of South Africa s priority expenditure within the fiscal accounts. The essential points drawn from the exercise carried out for South Africa s present circumstances are as follows: South Africa is currently in a tight fiscal position with marginal economic growth prospects, rising inflation and increasing debt as a proportion of GDP. With potential sovereign debt ratings downgrade on the horizon, South Africa justifiably intends to consolidate its debt by gradually decreasing its annual budget deficit as a percentage of GDP. Although fiscal consolidation might curtail any major expenditure increases, South Africa s buoyant tax revenue allows it to consolidate debt without major decreases in total expenditure. The expenditure decreases that are however planned are intended to be achieved through decreased wastage especially related to non-essential goods and services expenditure and compensation of employees. In terms of priority expenditure for children specifically, South Africa is, even in these austere times, still committed to maintaining and even increasing its expenditure on health, education and social development. Even at low levels of economic growth, South Africa should still be able to do this. Although South Africa is not in a position to expand its annual borrowings, at least in the medium term, if South Africa s tax revenue continues to outpace GDP growth, this increased tax revenue would be the primary source increased in the fiscal space for priority expenditure. Global commodity markets have been severely depressed which has seriously affected company income tax revenue in South Africa. An improvement in these markets could have a major impact on company income tax revenue. Another source for the creation of fiscal space for priority expenditure is a decrease in non-priority expenditure. Treasury intends to clamp down on underspending and underperformance as part of its austerity measures. If budgets in non-priority sectors are cut, there is a possibility that priority sectors could benefit if they are able to demonstrate sound financial management and the effectiveness of their programmes. However, in the medium term it is more likely that debt servicing will be prioritised in this regard. The remainder of this report is organised over six other sections: Section 2 summarizes South Africa s present macroeconomic circumstances; this is followed by section 3 which outlines a methodological approach to the fiscal-space analysis that UNICEF could see. Section Analysis of data in recent priority expenditure and its underlying financing flows describes the recent evolution of the priority expenditure flows and section 5 discusses various options available to policy makers to enhance the 4 (National Department of Basic Education, 2016). 5 (National Department of Health, 2015). 6 While it would be possible to carry out the kind of analysis this chapter describes using an enhanced set of accounts going beyond the official budget accounts, it may prove challenging to identify and incorporate all relevant expenditure programs and funding sources. 12

13 fiscal space. Section Formulation of different scenarios: exercise describes an illustrative exercise for the priority expenditure flows for the years based on various scenarios. The final section describes the mapping from funding sources to the priority and non-priority expenditure flows, for recent years and for future years in the base scenario. 13

14

15 2 Characteristics of the specific country situation Table 2.1 shows some of the basic macroeconomic indicators for South Africa for the fiscal years FY Table 2.1 South Africa's economic performance FY FY2015 FY10-11 FY11-12 FY12-13 FY13-14 FY14-15 Gross domestic product (millions US$ $ $ $ $ $ at FY14-15 prices and exchange rate) 7 Growth rate 4.1% 2.6% 2.3% 1.9% 1.0% Per-capita: Gross domestic product $6 286 $6 353 $6 403 $6 427 $6 393 (millions US$ at FY14-15 prices and exchange rate) 4 Growth rate 2.6% 1.1% 0.8% 0.4% -0.5% Non-government consumption $3 852 $3 841 $3 971 $3 911 $3 849 (millions US$ at FY14-15 prices and exchange rate) 8 Growth rate 1.8% -0.3% 3.4% -1.5% -1.6% Per cent of GDP: Gross fixed capital formation % 19.1% 19.3% 20.4% 20.6% Central-government fiscal -4.7% -4.7% -5.0% -4.4% -4.3% surplus 5 Merchandise-trade surplus % 52.5% 48.9% 48.9% 50.3% Growth rate: Consumer prices 5 (December) 5.5% 5.5% 6.6% 4.7% 6.3% Exchange rate 5 (December) -8.5% 19.5% 5.7% 20.1% 10.4% Growth rate: Population 9 1.4% 1.5% 1.5% 1.5% 1.6% Population under nineteen 6 0.3% 0.3% 0.4% 0.5% 0.6% Headcount poverty incidence % n/a n/a n/a n/a Source: (International Monetary Fund, 2017) (Statistics South Africa, 2016) (National Treasury, 2016). After slow growth during the global financial crisis, by 2010, South Africa s GDP recovered to precrisis levels in real terms. Ever since then, economic growth has gradually been slowing with real economic growth for 2016 expected at 0.5% (National Treasury, 2016). Figure 1 shows this is a pattern that has been emulated by the rest of the world as well as other emerging markets and developing economies (International Monetary Fund, 2015). South Africa s post-crisis recovery was 7 (National Treasury, 2016). 8 International Financial Statistics. 9 (Statistics South Africa, 2016). 10 World Development Indicators. 15

16 US$ (Real 2010 prices) Real GDP growth (Annual percent change) however more subdued and the GDP growth rate has remained lower ever since. Although South Africa s growth was below the average of other emerging markets and developing economies since and possibly before 2000, up until the global financial crisis in 2008, GDP in South Africa was very similar to the world average. The fact that since 2009, South Africa s GDP growth rate has consistently been below the world average implies that South Africa s economic difficulties go beyond the effects of a constrained global economy. Figure 2.1 Comparison of real GDP growth rates Emerging market and developing economies World South Africa Source: (GEM Commodities and World Bank Group, 2016). Nevertheless, South Africa s economy is very reliant on commodities and the decrease in world commodity prices have had a major impact on the South African economy. Figure 2.2 illustrates the magnitudes of this decrease. Between 2010 and 2016, the value of gold, platinum, iron ore and coal fell 19.4%, 41.9%, 44.2% and 64.8%, respectively 11. Figure 2.2 Commodity prices 1,800 1,600 1,400 1,200 1, Gold Platinum Coal Iron Ore 0 Source: (GEM Commodities and World Bank Group, 2016). 11 (GEM Commodities and World Bank Group, 2016). 16

17 As described earlier, South Africa s recent depressed economic growth and its divergence from the world average suggests that there are domestic factors that have influenced South Africa s growth path. Although electricity availability and reliability has improved, the economic impact of South Africa s electricity supply shortage was severe. In addition to the effect on the production in the mining industry, the South African energy supply deficit also led to higher electricity prices and subsequent general price inflation, lower producer confidence and subdued domestic and foreign private investment. These effects are still being experienced in the economy even though the supply of electricity has now caught up to the demand 12. More recently, South Africa has experienced the most severe droughts in 20 years. The effects of this drought filtered through to the rest of the economy quickly, with lower agricultural output leading to significant food price inflation. Additionally, South Africa s volatile but overall consistently depreciating currency has not only contributed to price inflation pressures, but is also a persistent source of economic uncertainty. The drought, the electricity shortage and the depreciation in the currency have all played a role in pushing up prices for consumers (National Treasury, 2016). South Africa is therefore currently in a position of low growth and high inflation which limits the role government can play to boost economic growth. Both fiscal and monetary policy aimed at stimulating growth will carry a very high risk of increasing inflation even more. South Africa has now officially moved into a position in which per capita GDP is decreasing as population growth is now higher than economic growth. Besides the fact that increasing government expenditure might put further upward pressure on inflation, according to South Africa s 2016 budget review, fiscal consolidation, rather than expansion has become priority. South Africa s cost of servicing its debt is the fastest growing line item in its budget. South Africa s expenditure on debt servicing was 3.2% of GDP in 2015/16 and 10.3% of total government expenditure. As can be seen in Figure 2.3, this is up from 2.3% of GDP and 7.6% of government expenditure in 2009/10. During this South Africa s debt servicing costs increased at an average annual nominal rate of 13.1% compared to GDP and government expenditure, which increased at an annual rate of 7.9% and 10% respectively (in nominal terms) (National Treasury, 2016). 13 (National Treasury, 2016). 17

18 Rand (Billions) % Figure 2.3 Costs of servicing debt / / / / / / /16 Debt-services costs as a percentage of GDP Debt-services costs as a percentage of Government Expenditure Source: (National Treasury, 2016). Figure 2.4 Total debt stock Source: (International Monetary Fund, 2017). Debt-services cost, a non-discretionary expense, is influenced by the amount of debt outstanding (debt stock), interest rates, inflation and exchange rates. Besides the amount of outstanding debt, the upward trend in interest rates and price inflation and the depreciating currency have all further increased the cost of servicing South Africa s debt. South Africa s annual borrowing requirement has remained relatively stable ranging between 3.6% and 4.3% of GDP between the 2010/11 and 2015/16 fiscal years. However, the borrowing requirement along with the currency depreciation has led to South Africa s net loan debt stock to annually increase at an average rate of 17% between 2010/11 and 2015/16. This has led to the net loan 14 debt as a percentage of GDP to increase from 29.8% in 2010/11 to 44.3% in 2015/16 (National Treasury, 2016). 14 Net loan debt is the net of gross loan debt and cash balances. 18

19 The South African government s revenue is directly dependent on economic growth. In light of global economic uncertainty, low commodity prices and low levels of consumer and producer confidence, it is doubtful that substantial economic growth will occur over the medium term. According to the 2016 budget, real GDP growth is expected at 1.7% in 2017 and 2.4% in 2018 (National Treasury, 2016). Subsequently, it is also doubtful that government revenue will grow substantially over this. Although government revenue has generally grown faster than GDP, substantial tax revenue increases are doubtful and with government s planned course of fiscal consolidation, decreases in overall government expenditure is the next logical step. According to the 2016 budget, the planned decreases in expenditure over the medium term will be mostly applied to compensation budgets and non-essential government departments goods and services. The plan is to control compensation budgets by blocking the filling of non-critical vacant posts pending the submission of revised human resources plans. The idea is for this to reduce the number of staff in administrative and managerial posts, eliminate unnecessary positions and establish sustainable levels of authorised, funded posts (National Treasury, 2016). From the perspective of priority expenditure, the South African government is still committed to increasing the expenditure in the health, education and social protection even in these times of fiscal consolidation. Over the next three years it is expected that on average, the spending in these sectors will grow at a percentage point faster than inflation annually (National Treasury, 2016). 19

20

21 3 Description of the model and data compilation The analysis of South Africa s recent and prospective priority expenditure and its fiscal space centres on the standard fiscal accounting identity. This identity states that total expenditure (comprising current, non-interest, interest, and capital expenditure) less the sum of total revenue and external grants is equal to the overall deficit, which is in turn equal to the net flow of external and internal financing. If total expenditure is broken down into the three categories of (1) priority and (2) nonpriority non-interest expenditure and (3) interest expenditure, this identity can be rearranged for any year as follows: Priority expenditure = Tax and non-tax revenue + External grants - Non-priority expenditure - External debt service - Internal interest expenditure + External debt disbursements + Net internal financing flows The below-the-line accounts taken together constitute the fiscal space for the priority-expenditure flow. For a retrospective analysis that is, for analysis of fiscal performance in historical years this structure can be applied directly to show how the below-the-line flows (the retrospective fiscal space) combined to finance the priority expenditure flows. Section 2.4 describes the quantitative analysis for South Africa, for the years For the analysis, the accounting identity is applied in a different way. For each year, the priority-expenditure flow is projected on the basis of programming assumptions, encompassing the various determinants of recurrent and non-recurrent expenditure in the education, health, social assistance and social welfare categories. Similarly, the below-the-line accounts, with the exception of the net internal financing flows, are projected on the basis of programming assumptions. The total net internal financing flow for each year is then calculated residually, so as to ensure that the accounting identity is satisfied. For a year, this net internal financing flow is the fiscal-space gap, that is, the difference between the projected priority-expenditure flow and the fiscal space. If this gap is too large, then the programming assumptions, taken together, would be considered unfeasible. The criteria for too large include the limits on the government s capacity to borrow in domestic financial markets and the implied increase in the government s debt-gdp ratio. The exercise is formulated by applying various assumptions, together constituting a scenario, to the historical data base. The relatively simplified, illustrative exercise discussed in Appendix 1 applies scenarios to historical data. Each scenario comprises programming assumptions for the years , covering: 21

22 World economic conditions; Basic South African macroeconomic variables; Merchandise exports and imports; Tax and non-tax revenue; External grants to the government; Government expenditure in the priority and non-priority categories; External and internal debt. For each scenario, some of the assumptions lines are set as simple numbers (growth rates, percentages of GDP, etc.). Many of the assumptions, however, are constructed from other assumptions. For example, the growth rates of real GDP and of the price level are numbers that the analyst chooses for any given scenario. It is straightforward to combine these assumptions into an assumed growth rate for nominal GDP. Below, section 1.4 describes the evolution of South Africa s priority expenditure and fiscal space in the years FY2011-FY2015, section 1.5 describes the various options available to policy makers to enhance fiscal space and section 1.6 describes the analysis for South Africa for the years FY2016-FY2020 based on various scenarios. 22

23 4 Analysis of data on recent priority expenditure and its underlying financing flows Over the years 2010/ /15 South Africa s priority expenditure and the fiscal-space flows evolved as shown in Table 4.1. The table below shows a general increase in priority expenditure relative to GDP over time. This fiscal space was created by increasing tax and non-tax revenue as well as some reprioritisation of non-priority expenditure over the same. Table 4.1 Fiscal Space 2010/ / / / /15 Total priority expenditure 9.5% 10.2% 10.3% 10.2% 10.3% Total education expenditure 4.9% 5.1% 5.0% 5.0% 5.0% Total health expenditure 3.3% 3.7% 3.8% 3.7% 3.8% Total social assistance expenditure 1.3% 1.3% 1.4% 1.3% 1.3% Total welfare expenditure 0.1% 0.1% 0.1% 0.2% 0.2% Overall fiscal space 9.5% 10.2% 10.3% 10.2% 10.3% Tax and non-tax revenue 27.0% 27.3% 27.3% 27.9% 28.6% External grant 0.0% 0.0% 0.0% 0.0% 0.0% Total non-priority non-interest expenditure -19.3% -18.2% -18.5% -18.7% -18.9% External -debt disbursements 0.2% 0.4% 0.0% 0.5% 0.6% External debt service -0.3% -0.2% -0.5% -0.7% -0.6% Change in cash and other balances -2.3% -1.9% 0.1% -1.0% -1.1% Net internal financial flows 4.2% 2.8% 1.9% 2.2% 1.6% Source: Estimates and calculations from the workbook SAFS.xlsm. As mentioned earlier, in 2016, the South African government reaffirmed its commitment to protecting the social wage. According to the 2016 budget, resources allocated for health, education, social protection, community infrastructure and housing subsidies for poor South Africans account for 60% of spending (2016/17), and, on average, these budgets grow 1% faster than inflation over the next three years. (National Treasury, 2016). For the purposes of this report however, we are not as interested in the entire wage bill as we are in the areas of expenditure pertinent to the welfare of children. The four areas of priority are included in the table above and include the education sector (including teacher training), health sector, social assistance (government grants) and social welfare sector. A description of the expenditure items included in these sectors follow below, along with an analysis of each sector s historical expenditure. 4.1 Education expenditure Basic Education (pre-primary, primary and secondary education) in South Africa is a concurrent function meaning that both the national and provincial government are mutually responsible for the delivery of basic education services. For the purposes of this report, the provincial and national government s basic education expenditure was aggregated and added to the National Department of Higher Education s expenditure on teacher training. 23

24 Public spending on education, according to this definition, has remained relatively constant as a percentage of GDP between 2010/11 and 2014/15. The figure below uses the South African Reserve Banks s data on consolidated government expenditure, to show that, although expenditure on preprimary, primary and secondary education has decreased as a percentage of total government expenditure since 2002, it has remained relatively constant since Between 2005 and 2014, expenditure on basic education as a percentage of total government expenditure has ranged between 10.1% and 11.3%, growing at an average annual real rate of 4.7% 15 Per-child basic education expenditure also grew at an average annual real rate of 4.7% between 2005 and 2014 according to data from the South African Reserve Bank as the child population has remained relatively constant over the same (Ibid). Although primary education expenditure has increased in real terms, in terms of percentage of total consolidated government expenditure, there has been a downward trend showing a certain amount of deprioritisation in the budget. The figure below shows this trend along with the concommitant upward trend in expenditure on tertiary education as a percentage of total consolidated government expenditure. Although this does not necessarily imply a direct transfer of funding from basic to tertiary education, given the recent student protests and the commitment by government to increase university funding and student support, this is a trend that should be closely watched as to protect the expenditure on primary and secondary education 16. Figure 4.1 Trend in proportion of education expenditure to total consolidated government expenditure Source: (South African Reserve Bank, 2016). Expenditure drivers The largest driver of expenditure in basic education is compensation of employees including, salaries and wages, training, travel and subsistence, medical benefits and housing allowances. In 2014/15, compensation of employees constituted approximately 82% of total provincial basic education expenditure. While non-staff recurrent provincial expenditure on basic education has increased annually at 7.4% per year since the 2010/11 financial year, provincial compensation of employees expenditure has only increased at 7.2%, causing the proportion of total expenditure on employee 15 (South African Reserve Bank, 2016). 16 These student protests and their potential implications are discussed in detail in the Political Economy Analysis. 24

25 compensation to decrease slightly. 17 It has to be mentioned here that during interviews with the Department of Basic Education, it was revealed that a large part of the non-staff goods and services budget is often allocated to teacher compensation and that the actual proportion of total expenditure allocated to compensation of employees is closer to 90%, significantly higher than the DBE s own benchmark of 80%. The declaration in the 2015 provincial budgets and expenditure review that an improvement in human resources management could lead to significant cost-savings and efficiency improvements in the sector is therefore extremely important. Specific areas of improvement relate to ensuring that provinces can afford the number of people employed, that those employed have the necessary skill and that they are placed at schools where they are needed. A persistent issue in the school system is what is known as double-parking where excess teachers continue to be employed where they are not needed while schools that do need them experience a teacher shortage 18. Sufficient learner and teacher support materials such as text books, stationary and sports equipment, the National School Nutrition Programme (NSNP), teacher development programmes and learner transport provision are just as important as quality teachers for the functioning of the basic education sector in South Africa. Inefficiencies related to goods and services include the late payment of suppliers and late delivery of materials as well as deliberately spending less on goods and services to mitigate for over-expenditure on compensation of employees due to the aforementioned human resources management inefficiencies 19. Although unequivocally positive developments in the sector, the introduction of legislated norms and standards and a no-fee policy for public schools put further upward pressure on expenditure in the sector making efficiency improvements even more essential. 4.2 Health expenditure For the sake of the expenditure and fiscal space analysis, we have included all the provincial and national expenditure in the health sector. Although it can be argued that not all health expenditure directly benefits children, we felt that due to the secondary benefits of a healthy society to children, we should include the entire sector s expenditure. We will therefore start this section by analysing this expenditure after which we will take a closer look at the expenditure of the government programmes that are directly related to the work done by UNICEF. Over time, South Africa has increased the level of priority given to the health sector. Figure 4.2 shows us that health expenditure as a percentage of GDP increased between 2010/11 and 2014/15. As a percentage of total government expenditure, as health expenditure in real terms grew 2.6 percentage points faster than total government expenditure between 2002 and 2014, the proportion of health expenditure to total expenditure has also increased (South African Reserve Bank, 2016). Expenditure drivers The growth in health sector expenditure has mostly been driven by growth in compensation of employees which increased from 63.9% of total public health expenditure in 2010/11 to 65.3% in 2014/15. Increases in this expenditure item can primarily be ascribed to rapid increases in the number of health sector employees and annual public sector salary increases that consistently exceed inflation (National Treasury, 2016). Although not as rapid, expenditure on goods and services have also grown significantly over time. Although this growth has primarily been driven by increases in expenditure on antiretroviral medicines, there has also been significant increases in expenditure on 17 (National Treasury, 2015). 18 (National Treasury, 2016). 19 (National Treasury, 2016). 25

26 non-negotiable items. Non-negotiable items are consumables such as medicines and medical supplies that have been identified by the National Department as being pillars of health delivery and have to be prioritised by provinces when budgeting 20. Figure 4.2 Provincial departments of health expenditure (Including Conditional Grants)Figure 4.4 Provincial departments of health expenditure (Including Conditional Grants) Source:. The increase in this expenditure is specifically important within the context of the implementation of South Africa s proposed National Health Insurance (NHI) System. The NHI will be a system focussed on Primary Health Care which will utilise a District Health System as its platform for service delivery. The re-engineering of Primary Health Care services is already underway with the Integrated School Health Programme, the Community Health Care Workers and the District Clinical Specialist teams as its pillar. For the full implementation of NHI, investment and subsequent improvement in the District Health System is therefore necessary and it could therefore be expected that District Health Services Programmes at National and Provincial level will receive a lot of attention going forward. In addition to the necessary scale up of expenditure on District Health Services, consistent increases in facility and vaccination utilisation rates have also contributed to the expenditure increases in this area. Below goes a little deeper into programmes at national and provincial level that are specifically related to health services for children. The government defined purposes of each of these programmes and sub-programmes below make it clear why these programmes are highlighted 21 : Women s Maternal and Reproductive Health: Develops and monitors policies and guidelines, sets norms and standards for maternal and women s health services, and monitors the implementation of these; Child, Youth and School Health: Responsible for the policy formulation, coordination, and monitoring and evaluation of child, youth and school health services and plays a key role in promoting improved child and youth health and nutrition; District Health Services. The national department coordinates and institutionalises the district health system; integrates programme implementation using the primary health care approach; and implements the stream of primary health care re-engineering (Community Health Workers, Integrated School Health Programme and the District Clinical Specialists Teams) on ward based 20 (National Treasury, 2016). 21 (National Treasury, 2016). 26

27 primary health care outreach teams inclusive of community based services. At the provincial level the District Health Services programme renders primary health care services, district hospital services, comprehensive HIV and AIDS care and nutrition. It includes the delivery of priority health programmes. Although not all of these services are exclusively related to children, we felt that this programme is essential to child health; Health Promotion and Nutrition: Formulates and monitors policies, guidelines, and norms and standards for health promotion and nutrition. Focusing on South Africa s quadruple burden of disease 22, it implements the approved health promotion strategy to reduce risk factors for disease, and promotes an integrated approach to work towards an optimal nutritional status for all South Africans. As is the case with district health services, although this programme is not exclusively targeted at children, the programme as a whole is imperative to the health of children in South Africa. Figure 4.3 shows the growth of total National Department of Health expenditure and its breakdown according to the most pertinent expenditure programmes. Over the illustrated, the National Department of Health s expenditure grew at an average annual real rate of 17.2%; significantly higher than GDP and total government expenditure. Approximately 21.3% of total expenditure is allocated to the HIV and AIDS, Tuberculosis, Maternal and Child Health expenditure programme. Within this expenditure programme, the majority of spending is allocated to HIV/AIDS and Tuberculosis with Women s Maternal and Reproductive Health, and Child, Youth and School Health receiving 1.7% and 28.9% respectively in 2014/15. This is a significantly increased proportion from 2010/11 when the programmes received 0.8% and 9.4% of the allocation respectively. Expenditure on primary health care, which includes District Health Services, and Health Promotion and Nutrition is also specifically important to children. Figure 4.4 also shows that this expenditure has grown faster than the total national health budget, increasing its share from 5.6% in 2010/11 to 6.1% in 2014/15. Figure 4.3 National Department of Health (excl. Conditional Grants) Source: (National Treasury, 2016). 22 HIV/AIDS, Tuberculosis, maternal and child mortality, violence and injuries and Non-Communicable Diseases. 27

28 As mentioned earlier, health care is a concurrent function in South Africa with most spending occurring at provincial level. At this level, District Health Services spending is most important to children as primary health care is delivered through the District Health System. Over the illustrated, the proportion of total expenditure on district health services at provincial level has remained relatively stable ranging between 43.1% and 44.6% of total provincial health expenditure growing at a real average annual rate of 5.4%. Figure 4.4 Provincial departments of health expenditure (Including Conditional Grants) Source: (National Treasury, 2016). The increase in this expenditure is specifically important within the context of the implementation of South Africa s proposed National Health Insurance (NHI) System. The NHI will be a system focussed on Primary Health Care which will utilise a District Health System as its platform for service delivery. The re-engineering of Primary Health Care services is already underway with the Integrated School Health Programme, the Community Health Care Workers and the District Clinical Specialist teams as its pillar. For the full implementation of NHI, investment and subsequent improvement in the District Health System is therefore necessary and it could therefore be expected that District Health Services Programmes at National and Provincial level will receive a lot of attention going forward. 23 In addition to the necessary scale up of expenditure on District Health Services, consistent increases in facility and vaccination utilisation rates have also contributed to the expenditure increases in this area Social assistance expenditure South Africa has an enormous social grant system with 16.6 million citizens receiving one or more of the seven types of grants 25 available in 2014/ Total expenditure on social grants as a percentage of GDP and total consolidated government expenditure during 2014/15 was 3.1% and 10.2% respectively. However, not all the social grants can be seen as directly affecting children. For the 23 (National Department of Health, 2015). 24 (National Treasury, 2016). 25 Child Support Grant, Care Dependency Grant, Disability Grant, Grant-in-Aid, Older Person s Grant War Veterans Grant and Social Relief Grant. 26 (National Treasury, 2016). 28

29 purposes of the fiscal space analysis, we have therefore aggregated the expenditure of the following grants 27 : Foster Care Grants for children placed in foster care; Care Dependency grants provide income support to parents and caregivers earning less than R (single) and R (married) a year, to help them care for children who are mentally or physically disabled; Child Support Grants provide income support to parents and caregivers of children under 18 earning less than R (single) and R (married) a year. Figure 4.5 shows as that this expenditure has remained relatively constant as a percentage of GDP since 2010/11. Figure 4.5 Expenditure per beneficiary Source: (National Treasury, 2016). Figure 4.5 illustrates the increases in per beneficiary expenditure on grants between 2010/11 and 2014/15. Even with increased coverage over the illustrated, both the Care Dependency and Child Support Grants have grown at a rate greater than inflation with real average annual growth rates of 1.8% and 0.3% respectively. Due to the total expenditure on the Foster Care Grant falling at an average annual real rate of 1.5%, the expenditure per Foster Care Grant Beneficiary has however decreased in real terms. During the 2017 budget speech, it was announced that the per beneficiary Foster Care and Child Support grants expenditure would increase by 3.3% and 5.5% respectively which, given the current inflation rate, would result in a real decrease per beneficiary in the 2017/18 fiscal year. Over the medium term however, National Treasury expects total expenditure on these grants to continue increasing due to inflationary adjustments to the grant value as well as further coverage expansion (National Treasury, 2016). 28 (National Treasury, 2016). 29

30 4.4 Social welfare expenditure Besides social grants, the National Department of Social Development also provide further welfare services to children. Within the Welfare Services Policy Development and Implementation Support Programme at the national department, the Children, Families and Youth sub-programmes were deemed most important to children and included in the fiscal space analysis. These sub-programmes fulfil the following functions 29 : Children: Develops, supports and monitors the implementation of policies, legislation, and norms and standards for social welfare services to children; Families: Develops, supports and monitors the implementation of policies, legislation, programmes, and norms and standards for services aimed at strengthening families; Youth: Facilitates and supports the implementation of strategies and programmes to mobilise youth for effective participation in social change and leadership programmes. Figure 4.6 shows expenditure on Welfare Services Policy Development and Implementation Support has exhibited a consistent upward trend since the 2010/11 fiscal year increasing at an average annual real rate of 5.1%. Within this expenditure programme, the Children, Families and Youth subprogrammes have also shown consistent average annual real growth of 15.2%, 3.6% and 37.1% respectively. The fact that the National Department of Social Development s total expenditure grew at only 2.4% per year over the same shows that these areas are experiencing an increased level of priority within the Social Development budget. Figure 4.6 Expenditure on Welfare Services Policy Development and Implementation support Source: (National Treasury, 2016). At the provincial departments of social development, the Children and Families programme is most pertinent for the fiscal space analysis. This programme covers care and services to families, children and youth care centres, child care and protection, community-based services for children, Early Childhood Development (ECD) and partial care for children. Figure 4.7 illustrates how, since 2010/11, provincial Children and Families expenditure has increased as a proportion of total provincial social development expenditure from 21.7% to 35.9% in 2014/15 illustrating and increased level of priority. This proportional increase is explained by the expenditure in this area increasing at 13.6% per year 29 (National Treasury, 2016). 30

31 in real terms, significantly above the average annual real growth rate of the total provincial social development expenditure. Figure 4.7 Provincial Departments of Social Development expenditure Source: (National Treasury, 2016). Over the medium term the National Department of Social Development aims to achieve the following objectives (quoted verbatim from the 2016 budget review): Facilitate the improvement of early childhood development services by: - revising the programme of action in 2016/17 to phase in the implementation of the early childhood development policy over the long term; - subsidising an additional children through the new early childhood development conditional grant by 2018/19; - supporting conditionally registered facilities to comply with norms and standards by 2018/19. Strengthen child protection services by: - registering 100 per cent of adoption cases received from court in 2017/18; - screening persons working with children against the child protection register by 2018/19; - creating awareness on children s rights and responsibilities through annual commemorative days such as Child Protection Week, and Children s Parliament each year over the medium term. 4.5 Fiscal space Despite decreasing net internal financing flows and increasing external debt repayment over the 2010/ /15, overall fiscal space for priority expenditure did increase from 9.5% to 10.3% of GDP. This was achieved through increases in tax and non-tax revenue and decreases in non-priority expenditure and external debt disbursements. Over the past five years, tax revenue as a percentage of GDP has increased from 23.9% in 2010/11 to 26.2% in 2015/16. The most significant contributors to this increase in tax revenue has been 31

32 Personal Income Tax that has shown an annual real growth of 6.1%. Other significant contributors have been Value Added Tax (annual real growth of 3.6%) Company Income Tax (annual real growth of 3.9%), customs duties (annual growth of 5.6%) and Excise duties (annual growth of 4.0%). These tax instruments are responsible for 85% of South Africa s tax revenue and have all grown faster than GDP over the, which grew at a real rate of 2.4% per year on average. 30 The impact of the global financial crisis can be seen in the changes in the relative contribution to total tax revenue of Personal Income Tax and Company Income Tax. Figure 4.8 shows that the relative contribution of PIT decreased up until the year before the financial crisis and then increased after, whilst CIT did the opposite. According to the South African Revenue Services, the increase in PIT can primarily be ascribed to above-inflation wage settlements and more recently to increases in the average income tax rate 31. Although PIT seems to be quite protected from low levels of economic growth, the decrease in commodity prices, high level of price inflation and subsequent decreases in company profitability slowed down the growth in CIT revenue, changing its trajectory dramatically. VAT revenue seems to be relatively stable compared to PIT and CIT revenue in terms of its contribution to total tax revenue, even though growth in VAT revenue slowed after the global economic crisis as consumer expenditure decreased. The difference in buoyancy of the three main sources of tax revenue has significant implications for the fiscal space which will be discussed in section 1.5. Figure 4.8 Tax distribution according to main tax instruments Source: (South African Revenue Services and National Treasury, 2016). As previously mentioned, South Africa s debt-services costs (interest payments) is its fastest growing expenditure item and is approaching nearly 10% of total expenditure. The fact that South Africa s debt as a proportion of GDP has doubled since the 2007/08 financial year and the subsequent danger of a sovereign risk ratings downgrade has pushed the Treasury makes clear Treasury s fiscal consolidation position. The graph below also shows that South Africa s debt levels of 44.2% are currently the highest it has been since 1996/97. In the last five years it is clear that South Africa has relied increasingly more on domestic borrowing. 30 (South African Revenue Services and National Treasury, 2016). 31 (South African Revenue Services and National Treasury, 2016). 32

33 1994/ / / / / / / / / / / / / / / / / / / / / /16 % of GDP Figure 4.9 Net loan debt as a percentage of GDP 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Total Domestic Foreign Source: (National Treasury, 2016). 33

34

35 5 Options to enhance fiscal space In principle, policy-makers could be asked to consider enhancements to the fiscal space for priority expenditure by considering the following options: (1) increasing tax and non-tax revenue; (2) increasing external grants; (3) reducing non-priority expenditure, in particular, (4) reducing external debt service through agreements with creditors; (5) increasing external debt disbursements; and (6) increasing net internal borrowing flows. It is useful to consider each of these possibilities in the circumstances of fiscal constraint likely to prevail in South Africa over the next few years: 5.1 Tax and non-tax revenue South Africa s tax-to-gdp ratio has risen rapidly in recent years. Between 2009/10 and 2015/16 it rose steadily from 23.9% to 26.2% showing a significant tax effort by the South African government during times where economic growth was constrained 32. As mentioned earlier, during this same, the composition of South Africa s tax revenue also changed with PIT increasing as a percentage of total tax revenue and CIT decreasing showing the difference in their respective levels of tax buoyancy 33. Tax buoyancy is defined as the sensitivity of tax revenue to changes in economic growth. Table 5.1 shows us that South Africa s revenue from PIT seems to be very buoyant while CIT is less so as the CIT revenue growth decreased and PIT revenue growth accelerated during the of slowed economic growth after 2006/07. A large contributor to South Africa s slow-down since 2007/08 has been the global economic slowdown leading to lower commodity prices and subsequently lower profitability in some of South Africa s largest industries 34. If South Africa s economy recovers due to an improvement in world commodity prices, and the CIT revenue reacts positively to the economic growth in the same way as it did negatively when economic growth was constrained, there is a considerable possibility of significant increases in tax revenue and improvements in fiscal space. Table 5.1 Nominal growth rate of South Africa s PIT, CIT and VAT revenue against GDP PIT CIT VAT GDP 1996/ /02 8.7% 17.6% 11.2% 10.6% 2001/ /07 9.2% 23.0% 17.1% 12.1% 2006/ / % 5.0% 7.3% 10.0% 2011/ / % 6.0% 10.1% 7.3% Source: (South African Revenue Services and National Treasury, 2016). Although Table 5.1 shows very buoyant PIT revenue, growing faster than GDP on average between 2006/07 and 2015/16, this growth has to be understood in context. A primary contributor to this growth has been wage settlement increases that have persistently been above inflation 35. Although we do not make a judgement on these wage-settlements in this report, it is important to understand the various trade-offs of these annual increases. 32 (South African Revenue Services and National Treasury, 2016). 33 (South African Revenue Services and National Treasury, 2016). 34 (South African Revenue Services and National Treasury, 2016). 35 (National Treasury, 2016). 35

36 In the private sector, specifically in South Africa s mining sector, these wage increases affect company profits. Instead of therefore levying the tax on company profits the tax is levied on the employees income through PIT and on the goods and services purchased by them through VAT. Wage increases therefore, as we can see has happened since 2006/07, shift tax revenue from CIT to PIT and VAT. The effect of these wage increases in the private sector on fiscal space will therefore depend on whether the tax paid by the employees from the extra income exceeds the decrease in CIT paid by the companies from the decrease in profits. In the short run, public sector wage increases narrow fiscal space. An increase in a public servant s income is wholly added to public spending while only a portion of it is paid back in the form of taxes, leading to a net shrinkage of fiscal space. If the growth in PIT revenue is therefore driven by public sector wage growth rather than an increase in the number of tax payers or increases in the tax rate, those PIT growth figures in Table 5.1 should be interpreted accordingly. The longer-term impact of public sector wages increases is, however, less straightforward. Higher public sector wages could theoretically improve public sector efficiency; either through attracting better quality staff, incentivising better performance and/or retaining skilled staff for longer s. Increased efficiency could then result in either requiring fewer employees to achieve the same output or an increase in output for the same number of employees. If the latter occurs, fiscal space will decrease as the same number of employees is paid higher wages. However, if the former path is taken and the benefits from the efficiency gains outweigh the costs of higher wages, fiscal space could potentially increase in the long-run. This increased efficiency could then either result in funding fewer employees to achieve the same output or funding the same number of employees while increasing output. It could be argued that higher public sector wages could lead to an overall increase in public sector efficiency as more highly skilled employees are attracted by higher salaries. Theoretically therefore, higher public sector wages could indirectly lead to an expanded fiscal space by producing the same result while requiring less funding. Practically however, it is more likely that even if efficiency gains were to occur, the fiscal space available will not be affected; rather better results would rather be expected. Although South Africa has recently increased its top marginal tax rate by 1% point, budget documents do not indicate any plans to increase the PIT, CIT or VAT rates in the medium term. On the contrary, in the 2016 budget it is asserted that although they intend to support planned new policy initiatives going forward, they are weary of higher tax rates due to their ability to retard economic growth 36. The negative effect on consumption that resulted from an overall economic downturn also slowed down the growth in VAT revenue. VAT revenue grew tremendously prior to the 2006/07 and then slowed down along with the economic growth. Although more buoyant than CIT revenue, South Africa s VAT revenue also seems to be quite sensitive to economic slowdowns. Nevertheless, it has remained relatively constant as a proportion of total revenue over the last 20 years as seen in Table 5.1. C-efficiency is a calculated indicator of the overall performance of the VAT system. The indicator equals the ratio of actual VAT collections to the amount that would be collected under a perfectly enforced tax levied at the standard rate on overall final consumption. According to the IMF, the average c-efficiency ratios in South Africa between 2007 and 2013 were 63.6%. This is third highest 36 (National Treasury, 2016). 36

37 amongst Sub-Saharan African countries showing South Africa has little room for additional revenues mobilization by improvement of tax compliance and expanding tax base of VAT could be limited compared with other countries in the region. It has however been higher reaching approximately 70% in 2006 and 2007 showing that their might in fact be some room for improvement 37. Current tax proposals to increase revenue include increasing the fuel levy, the excise duties on alcoholic beverages and tobacco products, the transfer duty on property sales, the capital gains tax rates for individuals and companies, and implementing a tax on sugar-sweetened beverages. As there are trade-offs involved with all taxes, the benefits should always be considered along with the potential costs. The societal and health benefits, especially for children, from excise duties on alcoholic beverages and tobacco and the tax on sugar-sweetened beverages should be weighed up against the fact these taxes are often considered regressive; disproportionately punishing the poor. However, it is also often argued that the health benefits from these types of taxes disproportionately benefits the poor meaning that the impact of the taxes are progressive. The highly progressive nature of capital gains and property sales transfer duties is a great benefit. However, this benefit should also be weighed up against the potential impact these taxes could have on private sector investment and consequently economic growth. Given the importance of economic growth for fiscal space and debt sustainability, this is an extremely important point to consider. As mentioned, any tax will involve trade-offs, meaning the rates at which the taxes are levied are extremely important as they could potentially determine whether the benefits of a tax outweigh its costs Nevertheless, at the current rates, as proposed by Treasury, it is expected that these tax proposals will add approximately R11.6 Billion to the tax revenue aggregate. After the adjustment for income tax relief for lower income earners is considered, the 2015/16 tax proposals add R5.9 Billion to the 2016/17 tax revenue expectation or 0.45% 38. Currently there are no plans to increase VAT, PIT or CIT rates, and given that the revenue from these tax instruments constitutes such a large proportion of total tax revenue, it is doubtful that too much fiscal space can be created without it. 5.2 External grants Donor funding in South Africa is earmarked for specific projects and not for budget support. Although this type of funding contributes to fiscal space by alleviating the budget requirement, we were unable to include it into the fiscal space analysis. This was primarily due to data availability. Although there is information on the size of the grants received from donors, it is often difficult to immediately ascertain from the financial reports of the departments how much of the available funding was spent and on what. 5.3 Non-priority expenditure In its attempt to consolidate debt, South Africa plans to grow revenue at a faster rate than expenditure, decreasing the budget deficit by 7.8% per year from R157.9 Billion in 2015/16 to R123.6 Billion in 2018/ The slower growth in expenditure is planned to be achieved through decreases in 37 (International Monetary Fund, 2015). 38 (National Treasury, 2016). 39 (National Treasury, 2016). 37

38 compensation budgets, budgets for non-essential goods and services, and budgets of programmes with a history of underspending. Whether these savings will be used to decrease the budget deficit or whether it will merely be reprioritised and distributed deserving sector departments will depend on government s planning. The current focus on fiscal consolidation makes it more likely that the budget deficit would rather be addressed. As discussed earlier, South Africa, even in times of fiscal consolidation is fully committed to maintaining and even increasing expenditure in the social, education and health sectors. It can therefore be assumed that although there are efficiency gains to be made in these sectors in terms of the employee compensation and goods and services budgets, overall budget allocation and expenditure should increase while non-priority expenditure, 40 as a proportion of total expenditure, could decrease 41. It is doubtful however that the decrease in nonpriority expenditure will be fully transferred to priority areas. According to the current spending plans, the expenditure saved through these measures will primarily be used to fund higher education, contribute to the New Development Bank, increase the contingency reserve fund for small business development, strengthen government s planning, monitoring and evaluation capacity and decrease debt levels. If the priority sectors are to be considered for this reprioritisation of the budget in the future, it is important that they show sound financial management practice and are able to present documentation with proof of the cost-effectiveness of their services. 5.4 External-debt service Theoretically, South Africa could increase fiscal space through agreements with creditors, but it is doubtful that such concessions will be made in the near future as South Africa is too economically advanced to access such concessional debt. 5.5 External debt disbursements In general, macroeconomic policy specialists concur that it is inadvisable to use commercial external debt to fund education, health, or social-protection expenditure. The reasoning is straightforward: eventual returns to education and health expenditure are realized over decades, but debt service on commercial external debt is generally due within a decade. Concessional debt, with multi-decade terms and near-zero interest rates, is more realistic for such purposes. These types of debt instruments are something South Africa does not have access to. Nevertheless, although South Africa does borrow money externally to cover its annual shortfalls, South Africa attempts to manage its portfolio risk against benchmarks set by the World Bank. The benchmark for foreign debt as a share of total government debt is 15%. As at the end of the 2014/15 fiscal year, South Africa s external debt as percentage of total debt was 9.3% showing that it is still within the benchmark s level 42. Between 2010/11 and 2014/15 gross loan debt grew at a nominal average annual rate of 14.3% compared to 8.0% nominal annual GDP growth rate over the same showing an increasing foreign debt to GDP ratio. Between 2015/16, foreign debt is expected to grow at approximately 11.2% compared to an expected nominal average annual GDP growth rate of 8.2% showing even further decline in the foreign debt to GDP ratio. This also illustrates government s intention to consolidate its 40 The New Development Bank is a new initiative of the BRICS member countries. The bank s headquarters were officially established in February The bank will focus on lending money to developing countries to help finance infrastructure projects. 41 (National Treasury, 2016). 42 (National Treasury, 2016). 38

39 debt with the total annual financing requirement also budgeted to decrease from R172.8 Billion in 2015/16 to R151.3 Billion in 2018/ Another important risk to be taken into account when considering using external debt disbursements to create fiscal space is South Africa s recent sovereign debt rating downgrade by the three major ratings agencies. Prior to the first downgrade, the four primary triggers for a potential downgrade included 44 : Spending overruns in the short to medium term; Significantly slower economic growth; Heightened political instability; Slow progress in implementing domestic reforms to boost growth. Following an unexpected cabinet reshuffle though which the Finance Minister and his Deputy were relieved of their posts, S&P were the first to downgrade South Africa s foreign debt rating to below investment grade. According to the ratings agency: The downgrade reflects our view that the divisions in the ANC-led government that have led to changes in the executive leadership, including the finance minister, have put policy continuity at risk, Fitch quickly followed suit with Moody s, more recently also downgrading South Africa by one notch with a negative outlook. Consequently, at this stage, S&P and Fitch rates South Africa s foreign currency denominated debt at one notch below investment grade while Moody s rates South Africa s foreign and local currency denominated debt at one notch above. Although the currency market has not reacted as negatively to the downgrades as one might expect, the increase in foreign debt interest rates and the increased difficulty with which South Africa will access foreign finance could have severe long-term impacts. The fact that South Africa has recently also officially fallen into a recession further exacerbates the problem and will make it difficult to regain investment status. The potential for further credit ratings downgrades therefore not only make it important for South Africa to control its debt, but also justifies its budgeted fiscal consolidation and makes the need for accelerated economic growth that much more important. It also implies that over the medium term at least, using external borrowing to fund any fiscal expenditure is ill-advised. 5.6 Net internal borrowing The bulk of South Africa s public debt is comprised of short- and long-term domestic borrowings. Short-term domestic debt consists of Treasury Bills and borrowings from the Corporation for Public Deposits (CPD) while long-term domestic borrowings consist of the issuance of fixed-rate bonds, inflation-linked bonds and retail savings bonds. South Africa does not have a benchmark for how much domestic debt it can incur yearly or in total. However, as short-term bonds are more expensive with higher interest rates, there is a benchmark, as recommended by the World Bank, that the proportion of total domestic debt held in the form of Treasury Bills should not be higher than 15%. As of March 2015, this proportion was 12.6%, significantly below the threshold. Nevertheless, given the 43 (National Treasury, 2016). 44 (National Treasury, 2016). 39

40 price tag connected to these debt instruments, it would be quite inappropriate to use short-term domestic loans to fund priority expenditure 45. Domestic long-term borrowing constituted 77.8% of total public debt in 2014/15 and grew at an average annual nominal rate of 17.5% since 2010/11. Between 2014/15 and 2018/19, it is expected that the proportion of long-term domestic debt will decrease slightly to 77.6% and grow at a much slower average annual nominal rate of 9.6% as the government aims to reduce the budget deficit and annual debt accumulation according to its plans to consolidate fiscally 46. Although the composition of South Africa s debt stock is within its benchmarks and thresholds, as mentioned earlier, South Africa s overall debt stock as a percentage of GDP has risen significantly over time and is currently at level levels that it has not been in 20 years. Government s priority to stabilise the growth of total debt as a percentage of GDP over the medium-term is justifiable. It is therefore doubtful that there is potential for any significant fiscal space to be created through expansion in borrowings as the plan is to decrease the annual budget deficit. 5.7 Concluding remarks South Africa s intention to decrease debt stock as a percentage of GDP leaves the responsibility of creating fiscal space for priority expenditure to an increase in revenue and a change in expenditure dynamics. Even if all the tax proposals currently under review by Treasury are introduced, the effect on fiscal space will be marginal. The fiscal space that could be provided by tax revenue will rather be due to its relationship to GDP growth. The historical relationship between revenue from South Africa s primary tax instruments (VAT, PIT and CIT) and GDP implies substantial increases in revenue even if GDP growth recovers even slightly; especially if this growth is due to private sector industries improving following improved world economic conditions. In terms of expenditure, the austerity measures and strict tracking of departmental spending might lead to funding being deprioritised from sectors that are not spending their budgets effectively or efficiently. In this case, priority sectors have to be able to show that they are managing their funds well and maximising the effectiveness of their current budgets. This will substantially increase their chances of receiving increased funding through reprioritisation in the future. The remainder of this Fiscal Space Analysis describes the exercise and key findings of the sensitivity analysis. As always, the exercise depends on its quantitative assumptions. In that sense, the discussion following should be considered illustrative, although it is hoped that it conveys some sense of the orders of magnitude involved in the future evolution of South Africa s fiscal space. 45 (National Treasury, 2016). 46 (National Treasury, 2016). 40

41 6 Formulation of different scenarios: exercise Base scenario In presenting the base scenario, Appendix 1 describes the programming assumptions and characterises the results. The real-gdp growth rate (in South African Rand) is assumed to increase gradually to 2.2 per cent in FY Most of the remaining programming assumptions are intended as neutral, non-controversial, base-line assumptions that would produce no significant changes in the fiscal structure as the real economy grows. The main exception is that non-recurrent expenditure is assumed to rise to sustain real-gdp growth. The results of the base scenario provide a basis for comparison with alternative scenarios incorporating assumptions that differ from those of the base scenario. Under the base scenario, priority expenditures for children would average 11.1 per cent of GDP over the years FY Over these same years, in real terms, total priority expenditures for children would average US$ 1, per child at FY2015 prices and exchange rate. Under the base-scenario assumptions regarding tax and non-tax revenue, external grants, non-priority expenditure, and external- and internal-debt stocks and flows, the projected flows of priority expenditures for children would produce a fiscal-space financing gap that would have to be covered with internal financing. The required internal-financing flow would be relatively small, however, averaging just 1.5 per cent of GDP. Figure 6.1 shows a fiscal-mapping chart, with FY s according to the base scenario. The s are set out as percentages of GDP 47. In the stacked-bar presentation, funding sources are below and expenditure flows above the horizontal axis: in effect, the sum of everything above the horizontal axis funds everything below. For each year, the sum of all flows above the horizontal axis is precisely equal to the sum of all flows below the horizontal axis. Stated differently, the tax and non-tax revenue, the external grants, and external-debt disbursements, shown above the horizontal axis, together fund the priority expenditure, the non-interest non-priority expenditure, the external-debt service, and the (negative) internal financing flow, including internal interest. The net internal financing flows include the interest on the internal debt. 47 In the Excel file, it is straightforward to select alternative units of account, such as U.S. dollars, U.S. dollars at base-year prices and exchange rate, or U.S. dollars at base-year prices and exchange rate per child. 41

42 Figure 6.1 Mapping of fiscal space profile - base scenario per cent of GDP, FY2011 to FY2020 Source: Estimates and calculations from the workbook SAFS.xlsm. 42