The debt trap
Since the inception of independence, accumulating debt from foreign/international financial institutions has been synonymous with many developing countries. Feeble economic growth and increasing state debt can lead to a debt trap. A debt trap can occur when a government’s debt outweighs its revenue or when the economy does not grow fast enough to repay a government’s interest on its debt. The SA Financial Markets Journal suggests that the South African economic system’s continued maladministration potentially brings the country closer to a debt trap. Unfortunately, as the interest on debt increases, South Africa will have to borrow money to repay its debts which will continue the cycle of accumulating interest.
A general indicator that a country is moving towards a debt trap is by deducting the average cost of government debt from its average economic growth rate. If this is a negative gap and continues to grow, the country is vulnerable to a debt trap. An article by the Institute for Security Studies highlights the recent case of Sri Lanka, where their debt trap was more severe than merely accumulating interest. Sri Lanka seized strategic control over its port, Hambantota, where China epitomised the notion of debt-trap diplomacy. This form of diplomacy provides debt relief for the indebted country through an exchange of strategic infrastructure, national budget, land, or natural resources belonging to the debtor. Many African countries are likely to have a similar fate, whether offered this form of diplomacy by the Chinese or other international financial institutions like the IMF or World Bank.
In its recent assessment on South Africa’s public financial state, asset management firm Future Growth highlighted its concern about the debt to GDP ratio. When debt exceeds the GDP, SA’s budget balance cannot be consolidated. Since 2009, SA’s debt-to-GDP ratio is increasing, and with its economic woes, no stability is projected for the near future. As SA’s economy deteriorates, the government accumulates more debt while increasing its expenditure. In 2020, the government mentioned that debt servicing cost was the most rapidly growing expenditure on its budget. As debt servicing costs are on the rise, SA’s credit rating lowers, making it a risk country and increasing its repayment premiums. Unfortunately, this means that the average citizen will receive less from government spending and that SA draws nearer to a debt trap.
In the 2021 budget speech, Finance Minister Tito Mboweni mentioned the government’s efforts to stabilise the national debt at 88.9% of GDP by 2025, suggesting that the debt-to-GDP ratio will decline thereafter. The government believes its efforts will establish sustainable growth as its consolidated expenditure reaches R2 trillion annually, with the significant portion going towards social welfare. However, increasing national debt results in an increased cost of borrowing across the economy and an increased likelihood of higher taxation in the future. The consequence of increased debt-servicing costs is that resources made for infrastructure and social welfare, among others, are reallocated to the debt-servicing costs.
However, the Finance Minister insists that SA’s economy will grow over the forecasted average economic growth of the sub-Saharan region, at 3.3% this year. Yet, the government continues to borrow over R500 billion annually. The national debt will increase from R3.95 trillion (this year) to R5.2 trillion in 2023/24. Clearly, we owe a wide range of people too much money, from foreign investors, foreign banks, corporations, pension funds to international financial institutions, among others. Ironically, the Minister also noted that the government expects to collect only R1.21 trillion in taxes this year, R213 billion less than last year’s budget expectations. Making it the most extensive tax shortfall since the democratic dispensation.
State sovereignty refers to a particular state’s complete jurisdiction within its borders, granting the state political authority over its territory. According to Professor Ferreira-Snyman of the School of law at UNISA, absolute sovereignty is an outdated concept in international law due to globalisation. Modern society is increasingly interdependent, and states are more cooperative. As such, sovereignty is restricted by internationalisation and universal human rights. What is important to understand is that part of the authority that comes with state sovereignty is compiling the national budget. Unfortunately, apart from increased interdependence among states, those significantly indebted are more dependent on financial support, leading to debt accumulation and increased debt-to-GDP ratios.
Noel Villaroman of Monash University suggests that these indebted states are likely to experience budget constraints due to debt-servicing costs. These costs undermine developing countries’ government capacity to render basic services and social welfare to their citizenry. Unfortunately, SA’s increasing debt servicing cost and financial mismanagement challenges, among other developing countries, restrict its spending on the citizenry. Resources meant for education, healthcare, housing, services, and social grants are reduced in order to narrow the debt-to-GDP ratio, or they disappear with corruption. Consequently, these developing countries like SA are unable to establish sustainable economic development to better their people.
International financial institutions like the IMF are partly to blame. A debtor state cannot renegotiate its repayment terms to secure resources for its people without the IMF’s permission. When the IMF grants a loan, it agrees on a repayment agreement based on the debtor state’s future economic projections and financial conditions. Unforeseen economic hurdles like the coronavirus pandemic that caused severe negative economic growth are not considered, and debtor state’s premiums remain high. If a debtor state receives debt relief, it is in a multi-year agreement based on its standing with the IMF. State sovereignty can be compromised if a debtor state is unable to repay its debt. Undermined state sovereignty generally leads to a people’s inability to choose whatever type of government they wish. And creditor financial institutions can easily undertake their economic, social and cultural development.
Impact on South Africa
A debt trap problem will result in SA taking a serious turn for the worse. Certain state-owned enterprises might have to be privatised, social grants and state pensions will be severed. Government employees will be retrenched, or their salaries reduced, while citizens experience a tax hike. For this reason, a debt trap must be avoided. The question is, will our politicians take decisive action? In his research paper for the Centre for European Studies, Professor Michael Wohlgemuth said, today’s politicians that take debt are not the same ones who will request citizens to repay it tomorrow. The citizenry that holds state debt today is not the same as those who will account for it tomorrow. He highlights the cycle which creates inherent debt for the country and its youth, which ironically, in SA, are the most unemployed today yet are expected to repay national debt in the future.
Subsequently, “we owe ourselves,” and future generations will bear the burden. Unfortunately, government’s efforts to avoid a debt trap are limited; either the government increases tax revenue or reduces expenditure. The Finance Minister touched on some remedies that have been instituted, noting that the government aims to reduce the debt-to-GDP ratio to an average of 30% or ideally zero.
The National Treasury is also cutting wasteful expenditure by stopping government-issued cellphones for officials (costing R5 billion annually), reducing allowances and travel budgets, and freezing salaries of all political appointees (ministers, MECs, and mayors). Over the next two years, the government aims to reduce R49.5 billion worth of expenditure and continues to identify areas to cut to reach a reduction of R150 billion by 2023. Hopefully, these efforts are enough to save the country from a catastrophic financial and political decay of the Republic.
Ferreira-Snyman, M. 2006. The evolution of state sovereignty: A historical overview. University of South Africa. Fundamina, p. 1-2.
Gopaldas, R. 2020. Lessons from Sri Lanka on China’s ‘debt-trap diplomacy.’ Institute for Security Studies. https://issafrica.org/amp/iss-today/lessons-from-sri-lanka-on-chinas-debt-trap-diplomacy Accessed: 2021.04.21.
Luüs, C. 2021. Debt trap looming. SA Financial Markets Journal. https://financialmarketsjournal.co.za/debt-trap-looming/ Accessed: 2021.04.21.
Rakale, R., Furstenberg, W. January, Y. and Kilian, A. 2020. The state of South African public finance: How close are we to a debt trap? Future Growth. https://www.futuregrowth.co.za/insights/the-state-of-south-african-public-finance-how-close-are-we-to-a-debt-trap/ Accessed: 2021.04.21.
South African Government. Minister Tito Mboweni: 2021 budget speech. https://www.gov.za/speeches/minister-tito-mboweni-2021-budget-speech-24-feb-2021-0000 Accessed: 2021.04.21.
Villaroman, N. 2009. The loss of sovereignty: How international debt relief mechanisms undermine economic self-determination. Journal of Politics and Law, Vol. 2(4), p. 3-11.