Why the IMF won’t swallow South Africa’s Kool-Aid

The International Monetary Fund’s (IMF’s) latest assessment of the South African economy implicitly rejects the government’s narrative that it is undertaking sufficient, meaningful structural reforms that will lead to faster growth, or that the planned fiscal consolidation will stabilise the debt ratio. 

The IMF expects the growth rate to slow to just 0.1% this year on intense load-shedding but rebound to 1.4% next year as the energy crisis eases and global growth strengthens. However, it then expects growth to taper off to average just 1.5% over the medium term.  

This is because it expects long-standing structural impediments, such as labour market rigidities and human capital constraints, to offset expected improvements to the country’s energy supply, private investment in energy-related infrastructure, and a more supportive external environment.  

It’s a bleak prognosis in which South Africa fails to get on top of its many challenges, materially raise per capita GDP growth or reduce unemployment and poverty. The sluggish pace of growth also means that the country’s fiscal position will continue to deteriorate, with the gross debt ratio set to worsen steeply to 85% of GDP by 2028 from about 71% now. 

The key message from the IMF report is that further reforms are “urgently needed” to durably lift the country’s growth potential and address pressing social challenges. 

Speaking to the FM from Washington, IMF mission chief for South Africa Papa N’Diaye notes that only 10 of the 35 reforms identified by Operation Vulindlela have been fully completed so far. 

“These are challenging times that provide an opportunity to implement far-reaching reforms,” he says. “The upside potential is there, but it will require more progress on the reform front.” 

The IMF recommends further measures to reform state-owned entities (SOEs), open key network industries to private sector participation, reduce the regulatory burden, enhance labour market flexibility, and improve the quality of education.  

The top priority should be resolving the ongoing energy crisis, the report states, noting that Eskom’s operational performance continues to deteriorate and that its financial position remains challenging. 

The key message is unequivocal: “More needs to be done.” 

N’Diaye describes South Africa’s fiscal position as “challenging”, noting that many of the downside risks that were flagged at the time of the 2023 national budget in February have materialised, including a higher-than-expected public sector wage settlement. 

Whereas the National Treasury was expecting that the consolidated budget deficit would drop to about 3% over the medium term and that debt would stabilise at about 73% by 2025/2026, the IMF expects fiscal deficits to keep climbing towards 7% and for the debt ratio to hit 77% over this period. 

Part of the reason for the divergence is that the IMF includes Eskom’s R254bn three-year debt relief package in its calculation of the deficit whereas the National Treasury tucks it below the line.  

The IMF also has a weaker growth outlook, expects future wage settlements and SOE bailouts to continue to put pressure on the fiscus, that falling commodity prices will weaken tax revenue, and that the social relief of distress grant (which costs at least R36bn a year) will become permanent. 

As weak as its base case is, the IMF warns that things could turn out even worse given the “significant” downside risks to its forecast. 

In its downside scenario, South Africa suffers a huge recession this year caused by a deterioration in the global environment and more severe power outages. GDP contracts sharply by 1.8% in 2023 and recovers very slowly due to South Africa’s ongoing structural constraints, averaging under 1% between now and 2028. Unemployment rises above 37% and fiscal deficits climb rapidly above 8% of GDP, pushing the debt ratio to 85% by 2026 and 93% by 2028.  

 Joint Statement by the heads of FAO, IMF, World Bank, WFP and WTO

The country would likely face a fiscal crisis. Bank capital and profitability would weaken, capital outflows would intensify, the currency would depreciate further, and the sovereign risk premium would rise. 

Fiscal financing would rely increasingly on the domestic investor base, further deepening the sovereign/financial sector nexus, crowding out private investment and weighing down growth in an “adverse feedback loop”, warns the IMF. 

N’Diaye defends the IMF’s decision not to include an upside scenario in its latest report, noting that it did so in the 2021 report, showing that South Africa could raise the growth rate to 3.5% if various reforms were introduced. 

“It’s not that we don’t contemplate any upside potential,” he explains, “but we do see the balance of risks as tilted to the downside and [that] a confluence of these factors could exact a heavy toll on the South African economy.”  

Asked to put odds on the likelihood of the downside scenario materialising, N’Diaye says it is more than a remote tail risk, but not as likely as the IMF’s base case: “It is something we need to keep in the back of our minds in making policy decisions to guard against the risks.” 

Given the IMF’s view that South Africa’s fiscal position will continue to deteriorate on current policies, it encourages the National Treasury to undertake stronger fiscal consolidation equal to 3% of GDP over three years to put public debt on a firmly declining path towards 60%–70% of GDP — a level consistent with most debt ceilings globally. 

While South Africa’s deep domestic capital markets reduce the near-term fiscal funding risks, the IMF notes that its public debt ratio is now among the highest in emerging markets.

This leaves limited fiscal space to mitigate future shocks, including from contingent liabilities, SOEs, social spending needs and climate events. It also exposes the government to rising borrowing costs and the financial system to increased risk. 

One way to reduce sovereign risk would be the introduction of an explicit debt ceiling — something the IMF has recommended year after year and urges again in the 2023 report. 

N’Diaye says introducing a debt ceiling would signal to investors that the government is serious about keeping its books in order. This would strengthen the credibility of the fiscal framework and could provide significant debt service cost savings, given the sensitivity of the sovereign risk premium to the build-up of debt. 

The National Treasury has previously rejected this recommendation, however, arguing that fiscal rules could bring rigidities and constrain fiscal space to address the structural challenges the country faces. 

The proposed fiscal consolidation equal to 3% of GDP would require, in the absence of additional savings or higher taxes, cutting expenditure by about R70bn a year for three years. That’s roughly equivalent to the annual public health budget for goods and services, and is not remotely politically feasible, especially in and around a national election.  

First, wage bill rationalisation. The financier estimates that South Africa could save 2% of GDP if it were to apply below-inflation cost-of-living adjustments and reduced allowances and pay progression. 

Second, SOE reform that involves the divestiture, liquidation or restructuring of state entities to ensure their financial viability. This could achieve a permanent reduction of budget support equal to about 1.5% of GDP. 

Third, procurement reforms. Based on the government’s procurement review, the IMF notes that SA could cut 20% off government spending on goods, services and public works through more efficient procurement processes — a potential saving of up to 1.3% of GDP.  

Fourth, by limiting tertiary education subsidies to only vulnerable households South Africa could save about another 0.5% of GDP, in line with Treasury estimates. 

In response to the report, the Treasury says it is aware of the significant downside risks to economic growth and will update its macroeconomic forecasts in the October medium-term budget. 

“Government is navigating this difficult environment with policies that support faster growth,” it said in a statement, “and addressing fiscal risks through ensuring a stable macroeconomic framework, implementing growth-enhancing reforms and strengthening the capacity of the state to deliver quality public services, invest in infrastructure and fight crime and corruption”. 

The Treasury says it remains committed to ensuring that debt stabilises in 2025/2026 as planned, and it will consider the IMF’s recommendations to ensure that fiscal imbalances are addressed.