Fiscal regime changes and the sustainability of fiscal imbalance in South Africa: a smooth transition error-correction approach

Abstract

In addition to the conventional linear cointegration test, this paper tests the asymmetry relationship between fiscal revenue and expenditure, by making a distinction between the adjustment of positive (budget surplus) and negative (budget deficit) deviations from equilibrium. The analysis uses quarterly data for South Africa. The paper reveals that government authorities in South Africa are more likely to react more quickly when the budget is in deficit than when in surplus, and that the stabilisation measures used by government are fairly neutral at low deficit levels; that is, at deficit levels of 4 per cent of GDP and below. We conclude that the assumption that adjustment towards equilibrium is always present and of the same strength under all circumstances, is not valid in the case of fiscal data on South Africa; and that that fiscal sustainability in South Africa has been attained at the expense of a reduction in the ratio of expenditure to GDP on education, and a relatively constant ratio of expenditure to GDP on health. The paper noted that a priori one would expect that such a decline in the allocations to sectors which could stimulate growth and which in turn could generate future revenue, may pose a threat to the accumulated fiscal space. In South Africa the main fiscal challenge, therefore, is to find ways through which the recent gains in fiscal solvency can be consolidated.