WHEN governments run out of money, the consequences are usually very painful. To reduce spending to what is affordable, governments must cut back services to their citizens. Inevitably the poor, who depend most on public services and grants, suffer most when spending falls.

Governments run out of money either because tax revenue falls, or their ability to borrow is curtailed. Russia and Venezuela are countries where previously high taxes from oil exports funded spending that is now unaffordable. Falling government spending and economic mismanagement will cause both economies to shrink 3% this year, according to International Monetary Fund forecasts.

In Greece government spending was previously sustained by huge borrowings that are no longer available. The government’s ability to provide services is even more drastically reduced because it must set aside a substantial part of present tax revenue to pay the interest due on past borrowings. As a result, spending on services today is much lower than what Greek citizens had become accustomed to before the 2009 financial crisis.

The adjustments required are especially severe because budget deficits and the level of debt Greece accumulated before the crisis were astonishingly high.

Debt was more than 160% of gross domestic product (GDP). It reached this level partly because previous governments camouflaged with fake statistics the true extent of the deficit and kept big amounts of debt hidden off the balance sheet. Lenders also mistakenly believed that because Greece is part of the euro currency area, its debt carried the same risk as Germany. So they bought Greek government bonds even when they suspected that country’s financial situation was more parlous than official statistics suggested.

Had the excessive spending of the past been used to acquire assets, the benefits would have been sustained and the effects of cutting back spending today would not have been so severe. Instead, the money was often squandered by corrupt officials and funded a system of political patronage. Public servants in Greece earned substantially more than their private-sector counterparts, yet often delivered little by way of public benefits.

In the recent election, the majority of Greek votes rejected the economic austerity international lenders imposed after Greece’s 2009 financial implosion. The new government wants the lenders to write off a large part of its debt so that it can pay less interest on the remaining debt and start borrowing again. The government is likely to find that it has little room for manoeuvre.

If it unilaterally reneges on a substantial portion of its debt, Greece could be thrown out of the eurozone. Ejection could be more painful than austerity. The government, Greek companies and many individuals would still have debts denominated in euros that they would have to repay in what is likely to be a very weak new national currency. Their indebtedness may worsen. Greece would likely find it even harder to borrow on global capital markets than at present because lenders would be reluctant to lend in an unproven national currency.

SA’s government has also exhausted its capacity to borrow. Fortunately, our circumstances are much healthier than Greece’s. But adjusting to new realities is nonetheless painful. South African government debt (45% of GDP) is much lower than Greece, but has risen sharply in recent years. It will rise further over the next few years because of continued budget deficits and slow economic growth. This has alarmed investors who buy the bonds our government issues.

The rating agencies are threatening to downgrade our credit worthiness to "junk" if borrowing is not curtailed. This is a worry because many global pension funds would then be forced to sell the South African government bonds they own. It would then be very difficult to continue funding our large deficits with the rest of the world (more than R100bn a year).

In response, the government is trimming unnecessary spending and intends raising taxes in next month’s budget to reduce the deficit without cutting back on services. However, the real problem lies in the parastatals that need large injections of funds to meet operating losses and fund critical expansion projects. The parastatals have reached their borrowing ceilings and the government cannot provide needed funds without triggering a downgrade of its own creditworthiness.

Accordingly, the government is looking to sell noncore assets to sustain critical capital spending. But the funds generated will be insufficient to fund more than a small part of its ambitious capital projects programme.

The obvious answer is for more private partners to operate alongside the government in the provision of infrastructure. This already happens with electricity wind farms and the toll roads on major national roads.

Political ideology is delaying greater use of such partnerships, but financial realities will eventually prevail. Hopefully it will be sooner than later, because the private sector has the ability to raise funds and bring projects to completion much quicker than the government. Time is of the essence in the case of electricity, otherwise power outages will be with us for a very long time.

By Gavin Keeton

Keeton is with the economics department at Rhodes University.

Source: Business Day