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The pandemic hit South Africa hard, forcing the government to put in place a national lockdown from March 2020, combined with a relief plan mobilising 10% of GDP, despite limited fiscal space. The recovery gained momentum from the end of 2020, as health restrictions became more targeted and gradually relaxed. Activity was interrupted by social unrest in July 2021 and was affected towards the end of 2021 by the new Omicron pandemic wave. Overall, growth rebounded to 4.8% in 2021 and is projected to reach 1.8% in 2022.
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The Covid-19 crisis has exacerbated the already deteriorating fiscal situation in South Africa. The current consolidation strategy, based on spending cuts and reprioritisation of spending items, has reached its limits and is insufficient to stabilise the debt ratio in the medium term and fund unmet public services needs. The tax-benefit system needs to be redesigned to create fiscal space in the years to come to finance growth-enhancing reforms and to reduce inequalities. The challenge is to generate additional revenues without generating inefficiencies or exacerbating inequality. Income taxes represent around half of total tax revenues, but are levied on small tax bases, partly reflecting the unequal distribution of income. Only the value-added tax has a relatively broad basis combined with a moderate tax rate. There is some scope to raise revenues further while reducing existing tax distortions, notably by broadening the base of corporate and personal income taxes, as well as consumption taxes. Taxes with a less harmful impact on growth, such as property taxes, are limited by the inefficient municipal rates system. There remains scope to further increase environmentally-related taxes.
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Productivity growth has been falling for a decade, hindering improvements in living standards. Low productivity reflects, firstly, poor infrastructure in telecommunications and transport. Secondly, the regulatory environment is not always business-friendly and often raises obstacles to firm entry, exit and expansion. Combined with weak competition in important sectors, this has led to lower private investment levels, particularly, business R&D. Finally, the educational and health care systems have been unable to supply adequately skilled workers across the country. To improve productivity, public investment needs to become more effective, notably by strengthening the selection process for large infrastructure projects. A more pro-competitive business environment would let productive firms grow and foster innovation. Widening and reducing inequalities in access to education and health care would reduce skill shortages.