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Deficits And Debt Ceilings

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What is a budget deficit?

A budget deficit occurs when a government’s expenditures become more than the revenue it has collected. It is common for governments to run a deficit and to use debt (bonds) to finance them. The interest from the debt needs to be paid out each year. If debt is too high, creditors’ concerns about a country’s ability to repay its debt rise and will hence demand higher interest rates. It becomes harder for governments to raise funds as their debt levels rise too far.

Faced with this problem, a country can either default or restructure its debt.

Defaulting

Argentina defaulted in 2001 on $81 billion worth in bonds and opted to devalue its currency to be able to pay its debt.

In 2012, Greece experienced the largest restructuring in history. After years of living beyond its means, high budget deficits and the poor economic climate made it difficult for the country to make payments on its bonds and led to downgrades and high interest rates on new debt. It eventually became too expensive for the country to roll over its debt, leading to the Greece debt crisis. The country is moving towards recovery.

Another route

Much closer to home, in April 2009, Liberia bought back $1.2 billion in commercial paper from its private foreign creditors. The debt, twice the country’s GDP and a quarter of the foreign debt, was bought back at an almost 97% discount of the face value. This was achieved after two years of negotiations and with the help of the World Bank, Germany, the United States (US), Britain and Norway.

In 2007, Liberia’s debt totaled $4.9 billion, 700% of GDP. That year the World Bank and African Development Banks reduced the country’s debt by $400 million and $250 million respectively. The previous default was in the mid-1980s.

Last year the world saw the US government’s shutdown. The financial year ended and a new budget had to be agreed upon by the House and Senate; without this, non-essential services were put on hold. The second issue was that the government had run a large budget deficit and its repayments were due. The Democrats wanted to increase tax while the Republicans called for a reduction in spending. A deal was struck and disaster averted.

In the first couple of months of the new financial year, the government’s deficit was reduced by 22%. Federal revenue climbed by 10% in the same period.

South Africa’s deficit

Rising debt costs and below target tax receipts are not helping ease South Africa’s debt. The 2013/14 budget deficit is forecast at 4.6% of GDP. Public sector borrowing increased to 7.4% of GDP in 2012/13. The country’s finance minister, Pravin Gordhan, has already vowed to maintain spending limits curbing wage growth. For the 2012/2013 tax season the South African Revenue Services collected R814 billion ($75 billion). Lower economic growth rates in recent years have made it hard to continue using tax revenue to reduce the budget deficit, and there has been an increased reliance on foreign investors to help finance budget deficit.

The South African government adopted a counter-cyclical fiscal policy to shield the country from the recent recession, which worked. On the flip side, the country moved from a surplus of 1.7% of GDP to a deficit.

It is clear, that unlike the general public, governments have a lot more options available to them when they fail to pay their bills. The lights won’t get shut off and the furniture repossessed.   FL

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