## 1. South Africa’s debt dynamics have weakened significantly over the last decade.

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### Debt evolution and main drivers
- Public debt increased from 23.6 percent of GDP in 2008 to 74.1 percent of GDP at end-2023.
- Under staff’s baseline projections, debt is projected to reach close to 86 percent of GDP by 2030.
- A quarter of fiscal revenues would be spent on debt servicing under the baseline projection.
- Main drivers of debt accumulation:
  - Consistent revenue underperformance (exacerbated by subdued growth and volatile commodity prices).
  - Unbudgeted transfers and contingent liabilities related to SOEs (averaging 0.7 percent of GDP annually over the last 10 years).
  - Rising debt servicing costs and unfavorable interest-growth differentials since 2010.
  - Pandemic-related pressures that worsened the public finances.
- Covid-19 specific impacts:
  - Growth in non-interest expenditures (main budget) in 2020 was 4.7 percent, compared to an average of 8.7 percent in the preceding three years.
  - Post-pandemic deficits averaged 5.6 percent of GDP, reflecting high global interest rates, multiple extensions of the Social Relief Distress (SRD) Grant, a sizeable public wage increase agreed in 2023, and materialization of contingent liabilities.
- Stock-flow adjustments materially increase debt:
  - Inflation-linked bonds constitute over 22 percent of total domestic debt portfolio; their share is expected to increase by 1 percentage point by 2026/27.
  - CPI inflation is expected to remain stable at 4.5 percent through the medium term, which is the rate at which the R1 trillion of the principal debt stock is expected to grow (minus redemptions).
  - Revaluation of inflation-linked bonds and foreign debt, and issuance at a discount (1.5 percent of GDP per year in recent years) contributed to debt increases. In 2023/24, revaluation of these components contributed 1 percent of GDP to the increase in debt.
  - The ‘discount from loan transactions’ added R59.6 billion (0.85 percent of GDP) to debt in 2023/24.

### Macroeconomic vulnerabilities and interest burden
- Around 21 percent of government revenues are currently spent on interest payments.
- Interest spending has outpaced all other spending items since the GFC.
- High debt and interest payments increase sensitivity to global financial conditions, push up sovereign yields, crowd out private investment, and constrain fiscal response to shocks.
- Empirical threshold evidence cited:
  - Debrun and Kinda (2013) estimated a threshold level of 26 percent (interest-to-revenue) beyond which sensitivity of primary balance increases.
  - Comelli and others (2023) suggest estimated thresholds for interest-to-revenue ratios between 16 to 19 percent robustly predict higher risk of upcoming fiscal stress.

### Assessment of the existing fiscal framework (expenditure ceiling)
- Framework description:
  - Since 2012 the main budget primary expenditure ceiling provides an upper limit for departmental budgets; ceilings are adjusted by inflation annually in the MTEF.
  - Nominal allocations for the current budget year are enshrined in law once budget-related bills are approved; two-years-ahead ceilings are indicative.
- Compliance and outcomes:
  - Non-interest expenditures have mostly remained within prescribed ceilings during 2009-2018; ceilings helped stabilize the spending-to-GDP ratio since 2009 except post-pandemic.
  - Since 2020, large revisions in ceiling levels occurred to account for Covid-19 and commodity-driven revenue changes.
  - Since 2023, SOE support (averaging 1 percent of GDP per year) has been excluded from ceilings and treated below the line.
- Why ceilings have not stabilized debt:
  - Missing anchor:
    - Despite debt sustainability being the key fiscal objective, expenditure ceiling calibration has allowed overall budget balances to remain in deficit and debt to rise throughout MTEF periods (exceptions: 2016, 2017, and 2024 projected falls in debt in final MTEF year).
    - No feedback loop between past debt outcomes and future ceiling calibrations.
    - Actual debt increases have been larger than MTEF budget projections.
  - Optimistic growth and revenue projections:
    - MTEF and ceilings calibrated around optimistic growth/revenue forecasts; revenue shortfalls are larger than expenditure forecast errors, causing deficit and debt overshoots even when nominal ceilings are complied with.
  - Discretionary adjustments:
    - Ceilings are set 3 years in advance and reviewed every 6 months; adjustments are discretionary with no clear pattern in size.
    - Asymmetric responses observed: example—2022 MTBPS revenue upward revision of R83.5 billion led to R37 billion ceiling increase; 2023 MTBPS revenue downward revision of R44.4 billion led to only R3.7 billion ceiling reduction, producing a deficit overshoot.
  - Misaligned wage negotiation cycle:
    - Public-service wage agreements are finalized after the budget cycle; preliminary compensation ceilings set in February, actual wage allocations reflected at MTBPS (October).
    - Wage bill outcomes in the last 3 years have exceeded respective annual budgets; 2023 required an in-year adjustment of 0.3 percent of GDP due to higher-than-budgeted wage agreement.
  - Exclusions from ceilings:
    - Large spending items excluded include payments financed by dedicated revenue flows and payments “not subject to policy.”
    - Recent notable exclusion: debt-relief support to Eskom averaging 1.1 percent of GDP per year between 2023/24 and 2025/26.

### Evidence on fiscal rules, outcomes, and institutional design
- Literature finds a positive relationship between adoption of fiscal rules and deficit and debt outcomes, with caveats on selection bias and endogeneity.
- Design features that improve rule effectiveness:
  - Institutional coverage, monitoring and enforcement bodies, statutory base, flexibility, correction mechanisms, and sanctions.
  - Empirical results cited: stronger rules associated with lower deficits, lower output volatility, and higher probability of successful fiscal adjustment (studies include Debrun and others 2008; Badinger and Reuter 2017; Caselli and Reynaud 2020; Davoodi and others 2023).
- Emerging markets and institutional quality:
  - Effectiveness in EMs is conditional on institutional quality, fiscal transparency, and compliance.
- Association with sovereign spreads and default risk:
  - Adoption and compliance with fiscal rules associated with lower sovereign spreads and default risk in a range of studies; magnitudes cited include reductions in spreads of around 1.1–1.8 percentage points and, in one compilation, 350 bps lower spreads for countries with fiscal rules (WB 2024).
- Limits to effectiveness:
  - Limited compliance, lack of political support, and excessive rigidity can undermine rules; overly rigid rules may prevent counter-cyclical response.
- Legal basis and social/political buy-in:
  - Strong statutory or constitutional basis and broad political/social consensus enhance durability and credibility (examples noted: Jamaica, Sweden).
- Flexibility provisions and escape clause design:
  - Escape clauses should have clear triggers, authority/conditions to trigger, limits on allowed deviation, and clarity on which rule elements are suspended.
  - Examples of quantitative limits: Colombia (deviation up to 20 percent of the output gap), Ecuador (1 percent of GDP increase in primary expenditures), Peru (deficit up to 2.5 percent of GDP against 1 percent rule), Panama (deficit up to 3 percent of GDP against 1.5 percent rule).
- Enforcement mechanisms and correction tools:
  - Among 104 countries with fiscal rules, 72 have formal enforcement mechanisms.
  - European Excessive Deficit Procedure (EDP) example: breach thresholds of 3 percent (deficit) and 60 percent (debt), deadlines to comply, and potential sanctions (fine of 0.2 percent of GDP or suspension of funds).
- Role and functions of independent fiscal institutions (fiscal councils):
  - Fiscal councils improve forecasting accuracy, compliance, reduce procyclicality, and support costing of measures; over 80 percent of fiscal councils in advanced economies had de-jure operational independence in 2021.
  - Key roles: watchdog, forecasts, compliance monitoring, and costing.

### Designing a fiscal rule for South Africa — calibration approach
- Two-step process proposed:
  - Step 1: calibration of a long-term fiscal objective (anchor), anchored to a stock variable (debt).
  - Step 2: select an operational rule to achieve the long-term debt anchor (e.g., expenditure or deficit rules), supported by escape clauses, adjustment mechanisms, and independent fiscal institutions.
- Debt anchor calibration approach (methodology):
  - Estimate maximum debt limit based on macroeconomic dynamics.
  - Determine safety buffer around maximum debt limit considering past volatility.
  - Long-term debt anchor = maximum debt limit − safety buffer.
  - Define intermediate medium-term debt objective as a step toward the long-term anchor.
- Conceptual notes and approaches for South Africa:
  - Comelli and others (2023) probit approach implies a maximum debt limit of around 73 percent of GDP.
  - Methods assuming a maximum primary surplus of 2.5 percent of GDP (historic average 2000–07) produce ranges of 60–100 percent of GDP depending on (r-g) calibration.
  - Endogenous-interest frameworks (MSS 2022) imply for South Africa: maximum debt limit of 80 percent of GDP assuming elasticity of interest rate to debt of 2.5 percent and maximum primary surplus of 2.5 percent of GDP; incorporating projected stock-flow adjustments squeezes the maximum sustainable debt to around 70 percent of GDP.
  - Jian, Sargent, Wang, and Yang (2024) endogenous-interest estimates suggest South Africa’s debt limit around 60–70 percent of GDP.

### Simulation findings, recommended anchor, and intermediate target
- Simulations use estimated distributions of macroeconomic and fiscal shocks based on historical data and stochastic simulations.
- A buffer of 10 percent of GDP would reduce the probability of debt surpassing 70 percent of GDP in South Africa to less than 10 percent.
- A debt anchor of 60 percent of GDP is judged to be prudent over the long term and is consistent with debt rule limits/anchors set by other EMs.
- Recommended interim target: reduce the debt-to-GDP ratio to 70 percent of GDP by 2030 as a step toward the long-term debt anchor of 60 percent of GDP.
- Comparative snapshot (counts by rule type):
  - Budget balance rule: 93
  - Debt rule: 85
  - Expenditure rule: 55
  - Revenue rule: 17
- Observed fact: Out of 85 countries with debt rules, only five have a debt rule on a standalone basis; the rest combine it with other rules.

### Operational rules taxonomy and trade-offs
- Four broad categories and characteristics:
  - Debt rule:
    - Sets explicit ceiling on public debt (percent of GDP); clear link to ultimate target but least controllable indicator.
  - Budget balance rules (BBRs):
    - Overall balance rule: simple and easy to communicate; can increase procyclicality and bias composition toward capital cuts.
    - Golden rule: excludes capital expenditures; avoids cutting public investment but risks excessive borrowing.
    - Primary balance rule: excludes interest payments; more directly under policymakers’ control but requires recalibration with changing debt dynamics.
    - Cyclically adjusted/structural rule: adjusts for cyclical changes; difficult to assess in real time.
  - Revenue rules:
    - Set floors or ceilings on revenues; seldom standalone; may increase procyclicality or limit revenue mobilization depending on design.
  - Expenditure rules (ERs):
    - Fully under government control; weaker link to debt dynamics; can be set in levels, growth rates, or percent of GDP; associated with lower procyclical bias and lower expenditure volatility but can affect investment and inequality.

### Policy recommendations for South Africa’s fiscal-rule design
- Tighten the existing expenditure rule and combine it with a primary balance rule:
  - Calibrate the expenditure rule to ensure a minimum improvement in the primary balance required to achieve the debt target.
  - Avoid exclusions (e.g., SOE support) to strengthen the link with debt dynamics and make the rule transparent and easier to monitor.
  - In case of upside revenue surprises, save additional revenues or use them for debt repayments.
  - Limit mid-year adjustments to spending reappropriations; use contingency allocations when fiscal risks are carefully calibrated and accounted for.
  - The combination of an expenditure rule and a primary balance rule could be more effective than the current framework, allowing consolidation on both revenue and spending sides in a downside surprise.

### Transitional arrangements, implementation prerequisites, and enforcement
- Transitional rules could:
  - Guide the fiscal position toward a steady state.
  - Address the immediate challenge of reversing rising debt and reaching the intermediate debt target of 70 percent by 2030.
  - Put the trajectory on a firm downward path until reaching the 60 percent fiscal anchor, after which rules could be reviewed and recalibrated.
- Implementation prerequisites:
  - Strong public financial and expenditure frameworks to accommodate urgent and unforeseen expenditure through reprioritization.
  - Enhanced capacity to identify and secure decisions to make expenditure savings.
  - Strengthened long-term fiscal-forecasting capacity and reporting.
  - Strengthened fiscal risk management, including risks arising from SOEs.
  - Assign an independent institution to assess budget assumptions and report on the government’s adherence to its strategy to enhance accountability and credibility.
  - A sound legal framework consistent with medium-to-long-term fiscal and debt policy objectives, with specific provisions for enforcement and independent monitoring.
- Enforcement design considerations:
  - Clear escape clauses with specified triggers, authority, and limits on allowed deviation.
  - Formal enforcement mechanisms and correction tools to specify corrective actions and timelines for returning to rule compliance.

### Conclusion — summary of implications and recommended framework
- The current spending rule in South Africa did not prevent the rapid rise in public debt over the past decade.
- Under the current staff baseline, debt is not expected to stabilize over the medium term as unfavorable interest-growth differential and sizable stock-flow adjustments are projected to more than offset a modest consolidation in the primary balance.
- To reduce debt vulnerabilities, putting public debt on a downward path toward a lower, more prudent level is essential.
- Recommended fiscal framework elements:
  - (i) a prudent debt anchor—estimated using a variety of methods, and accounting for a safety buffer—of around 60 percent of GDP in the long run, supported by an intermediate debt target of 70 percent of GDP in the medium run;
  - (ii) a credible fiscal rule, which could build on and strengthen the existing framework of expenditure ceilings, and be complemented by a primary balance rule, including well-defined escape clauses in case of large unforeseen shocks; and
  - (iii) assigning an independent fiscal body to assess the robustness of assumptions and report on implementation.
- Effective implementation requires a sound legal framework, strong supporting public financial and expenditure frameworks, and sound fiscal risk management practices.

*Source: sipea2025024 - 1. South Africa’s debt dynamics have weakened significantly over the last decade; 11. While fiscal rules have generally been found to be associated with better fiscal outcomes; 24. A more prudent debt anchor would ensure a high probability of not surpassing the maximum*

### 1. South Africa’s debt dynamics have weakened significantly over the last decade. The existing

### 1. South Africa’s debt dynamics have weakened significantly over the last decade. The existing

### Key findings on debt evolution and drivers
- Public debt increased from 23.6 percent of GDP in 2008 to 74.1 percent of GDP at end-2023.
- Under staff’s baseline projections, debt is projected to reach close to 86 percent of GDP by 2030.
- A quarter of fiscal revenues would be spent on debt servicing under the baseline projection.
- Main drivers of debt accumulation:
  - Consistent revenue underperformance (exacerbated by subdued growth and volatile commodity prices).
  - Unbudgeted transfers and contingent liabilities related to SOEs (averaging 0.7 percent of GDP annually over the last 10 years).
  - Rising debt servicing costs and unfavorable interest-growth differentials since 2010.
  - Pandemic-related pressures that worsened the public finances.
- Covid-19 specific impacts:
  - Growth in non-interest expenditures (main budget) in 2020 was 4.7 percent, compared to an average of 8.7 percent in the preceding three years.
  - Post-pandemic deficits averaged 5.6 percent of GDP, reflecting high global interest rates, multiple extensions of the Social Relief Distress (SRD) Grant, a sizeable public wage increase agreed in 2023, and materialization of contingent liabilities.
- Stock-flow adjustments materially increase debt:
  - Inflation-linked bonds constitute over 22 percent of total domestic debt portfolio; their share is expected to increase by 1 percentage point by 2026/27.
  - CPI inflation is expected to remain stable at 4.5 percent through the medium term, which is the rate at which the R1 trillion of the principal debt stock is expected to grow (minus redemptions).
  - Revaluation of inflation-linked bonds and foreign debt, and issuance at a discount (1.5 percent of GDP per year in recent years) contributed to debt increases. In 2023/24, revaluation of these components contributed 1 percent of GDP to the increase in debt.
  - The ‘discount from loan transactions’ added R59.6 billion (0.85 percent of GDP) to debt in 2023/24.

### Macroeconomic vulnerabilities and interest burden
- Around 21 percent of government revenues are currently spent on interest payments.
- Interest spending has outpaced all other spending items since the GFC.
- High debt and interest payments increase sensitivity to global financial conditions, push up sovereign yields, crowd out private investment, and constrain fiscal response to shocks.
- Empirical threshold evidence cited:
  - Debrun and Kinda (2013) estimated a threshold level of 26 percent (interest-to-revenue) beyond which sensitivity of primary balance increases.
  - Comelli and others (2023) suggest estimated thresholds for interest-to-revenue ratios between 16 to 19 percent robustly predict higher risk of upcoming fiscal stress.

### Assessment of the existing fiscal framework (expenditure ceiling)
- Framework description:
  - Since 2012 the main budget primary expenditure ceiling provides an upper limit for departmental budgets; ceilings are adjusted by inflation annually in the MTEF.
  - Nominal allocations for the current budget year are enshrined in law once budget-related bills are approved; two-years-ahead ceilings are indicative.
- Compliance and outcomes:
  - Non-interest expenditures have mostly remained within prescribed ceilings during 2009-2018; ceilings helped stabilize the spending-to-GDP ratio since 2009 except post-pandemic.
  - Since 2020, large revisions in ceiling levels occurred to account for Covid-19 and commodity-driven revenue changes.
  - Since 2023, SOE support (averaging 1 percent of GDP per year) has been excluded from ceilings and treated below the line.
- Why ceilings have not stabilized debt:
  - Missing anchor:
    - Despite debt sustainability being the key fiscal objective, expenditure ceiling calibration has allowed overall budget balances to remain in deficit and debt to rise throughout MTEF periods (exceptions: 2016, 2017, and 2024 projected falls in debt in final MTEF year).
    - No feedback loop between past debt outcomes and future ceiling calibrations.
    - Actual debt increases have been larger than MTEF budget projections.
  - Optimistic growth and revenue projections:
    - MTEF and ceilings calibrated around optimistic growth/revenue forecasts; revenue shortfalls are larger than expenditure forecast errors, causing deficit and debt overshoots even when nominal ceilings are complied with.
  - Discretionary adjustments:
    - Ceilings are set 3 years in advance and reviewed every 6 months; adjustments are discretionary with no clear pattern in size.
    - Asymmetric responses observed: example—2022 MTBPS revenue upward revision of R83.5 billion led to R37 billion ceiling increase; 2023 MTBPS revenue downward revision of R44.4 billion led to only R3.7 billion ceiling reduction, producing a deficit overshoot.
  - Misaligned wage negotiation cycle:
    - Public-service wage agreements are finalized after the budget cycle; preliminary compensation ceilings set in February, actual wage allocations reflected at MTBPS (October).
    - Wage bill outcomes in the last 3 years have exceeded respective annual budgets; 2023 required an in-year adjustment of 0.3 percent of GDP due to higher-than-budgeted wage agreement.
  - Exclusions from ceilings:
    - Large spending items excluded include payments financed by dedicated revenue flows and payments “not subject to policy.”
    - Recent notable exclusion: debt-relief support to Eskom averaging 1.1 percent of GDP per year between 2023/24 and 2025/26.

### Implications and context for reform
- Strong fiscal rules anchored in debt ceilings can strengthen debt sustainability and policy credibility through commitment and signaling effects, potentially lowering financing costs.
- Effectiveness of fiscal rules depends on design and careful calibration; empirical literature associates strong fiscal rules with higher probability of meeting consolidation plans and stabilizing debt.
- The authorities are exploring options to integrate debt sustainability objectives into fiscal planning and budgeting processes.
- The paper aims to draw lessons from technical and empirical work and country experiences to inform enhancements to South Africa’s fiscal framework (organization: Section B—evolution of debt; Section C—assessment of existing framework; Section D—empirical literature; Section E—design features and institutions; Section F—options for a debt anchor and supporting operational rules).

*Source: sipea2025024 - 1. South Africa’s debt dynamics have weakened significantly over the last decade. The existing*

### 11. While fiscal rules have generally been found to be associated with better fiscal outcomes,

### 11. While fiscal rules have generally been found to be associated with better fiscal outcomes,

### Evidence on association between fiscal rules and outcomes
- Literature indicates a positive relationship between the adoption of fiscal rules and deficit and debt outcomes (examples cited: Poterba (1996), Debrun and others (2008), Tapsoba (2012), Bergman and others (2016), Asatryan (2018), Heinemann and others (2018)).
- Presence of strong national fiscal rules extending to sub-national governments associated with greater probability of meeting adjustment targets and stabilizing debt ratios (Mauro and Villafuerte, 2013).
- Countries with strong fiscal rules more likely to stick to consolidation plans (Heylen, Hoebeeck, and Buyse, 2012).
- Caveats:
  - Selection bias and endogeneity may overestimate benefits of fiscal rules (Caselli and Reynaud, 2020; Heinemann, Moessinger, and Yeter, 2018).
  - Countries may adopt rules in periods of stress or after consolidation episodes to lock in gains.
  - Societal preference for fiscal discipline could drive both adoption of rules and positive fiscal outcomes.

### Design features that improve rule effectiveness
- Features identified as improving effectiveness: institutional coverage, monitoring and enforcement bodies, statutory base, flexibility, correction mechanisms, and sanctions.
- Empirical evidence:
  - US states: more binding rules have stronger disciplinary effects (von Hagen 1991; Bohn and Inman 1996; Clemens and Miran 2012; Lutz and Follette 2012).
  - European countries: stronger rules associated with lower deficits, even after correcting for selection bias (Debrun and others 2008; Afonso and Hauptmeier 2009; Bergman, Hutchison, and Hougaard Jensen 2016).
  - Badinger and Reuter (2017): countries with more stringent fiscal rules have lower deficits and output volatility.
  - Caselli and Reynaud (2020): moving from a relatively weakly designed fiscal rule to a better designed rule yields a positive impact on the fiscal balance of 0.6 ppt of GDP.
  - Davoodi and others (2023): stronger fiscal rules associated with stronger primary balances; countries with stronger budget balance rules (BBRs) have smaller and less frequent breaches.
  - Chrysanthakopoulos and Tagkalakis (2023): well designed fiscal rules increase probability to initiate and successfully conclude fiscal adjustment (panel of 40 AEs).
- Fiscal rule strength index construction notes:
  - Based on European Commission’s Fiscal Rule Index (2015) mapping IMF Fiscal Rule dataset: 1985-2021 and IMF Fiscal Council dataset.
  - Four institutional criteria: i) statutory or legal basis of the fiscal rule; ii) nature of the entity in charge of monitoring the fiscal rule; iii) enforcement and correction mechanism; iv) flexibility and resilience of the fiscal rules against shocks.

### Effect in emerging markets and role of institutional quality
- Impact in EMs conditional on institutional quality:
  - Ardanaz and others (2023): in Latin America and the Caribbean, countries that comply with fiscal rules show, on average, lower probability of public debt accelerations compared to non-compliers.
  - Manasse (2006): fiscal rules and fiscal responsibility laws tend to reduce deficit bias; however, fiscal frameworks do not exert independent effects when quality of institutions (proxied by ICRG vulnerability measures) is accounted for.
  - Gootjes and de Haan (2022): in a panel of 73 countries (2003-2013), fiscal rules make success of fiscal adjustments more likely only when fiscal transparency is sufficiently high.

### Association with sovereign spreads and default risk
- Adoption of fiscal rules associated with lower sovereign spreads in AEs and EMs:
  - Studies cited: Bayoumi, Goldstein, and Woglom (1995); Poterba and Rueben (1999); Johnson and Kriz (2005); Iara and Wolff (2010).
  - Eyraud (2018): non-complying EU countries with EU fiscal frameworks have sovereign spreads higher by 50–150 basis points on average compared to complying countries.
  - Davoodi and others (2022b): after exceeding a budget balance rule, a country is expected to have higher CDS spreads than adherents (90-country sample).
  - Gomez-Gonzales et al. (2022): introducing a fiscal rule lowers sovereign default risk and probability of a sudden stop.
  - Sawadogo (2020): adoption of fiscal rules reduces sovereign bond spreads and increases sovereign debt ratings for a sample of 36 EMDCs.
  - Thornton and Vasilakis (2017): adoption of fiscal rules reduces sovereign risk premia by 1.1–1.2 percent for debt rules and by 1.5–1.8 percent for budget balance rules (sample of AEs and EMDCs).
  - Afonso and Jalles (2019): similar impact of rules on sovereign spreads (1.2-1.8 percentage points).
  - WB (2024): countries with fiscal rules faced 350 bps lower sovereign spreads relative to countries without rules.
- Note: during global crises, credit markets may interpret mere existence of fiscal rules as a signal of fiscal responsibility; temporary abandonment during crisis may still leave expectation of restored discipline afterward.

### Limits to effectiveness: compliance, political support, and rigidity
- Limited compliance and lack of political support, together with excessive rigidity, can undermine effectiveness.
- Deviations from fiscal outturns vs targets common across regions and income groups (Reuter, 2015; Davoodi et al., 2022; Blanco et al., 2020; Larch and Santacroce, 2020; Larch and others, 2023; Ulloa-Suárez and Valencia, 2022).
- European sovereign crisis illustrates lack of political support can undermine rules’ effectiveness.
- Overly rigid rules can prevent counter-cyclical fiscal response to large exogenous shocks, worsening output outcomes when monetary policy is constrained (e.g., by the lower bound), eroding public support.

### Legal basis and social/political buy-in
- Stronger legal basis and broad social and political support can enhance durability and credibility of rules.
- Currently more than 60 countries have fiscal rules at or above statutory levels (examples noted: Armenia, Jamaica, Paraguay) or in constitutions (examples noted: Brazil, Denmark).
- Strong legal basis is necessary but not sufficient; social and political buy-in is key.
- Examples:
  - Jamaica: debt reduction from 144 percent in 2012 to 73 percent in 2023 supported by Fiscal Responsibility Framework; highlights importance of social consensus and reduced political polarization (NBER 2024).
  - Sweden: respect for rules associated with broad public and political consensus to limit deficits (Eyraud and others, 2018).

### Flexibility provisions and escape clause design
- Flexibility provisions (escape clauses) help avoid unduly large adjustments and maintain support.
- Escape clauses allow temporary deviation/suspension under exceptional circumstances (examples: EU 2011, Colombia 2011, Jamaica 2014, Grenada 2015).
- Design principles for escape clauses:
  - Trigger must be clearly specified (e.g., “state of emergency”, “natural calamity”, “extraordinary events threatening macro-stability”; or quantitative benchmark such as size of GDP contraction; or both).
    - Examples of triggers: Mexico, Germany, Switzerland (text triggers); Poland, Ecuador, Brazil, Panama (quantitative GDP contraction); Jamaica, India, Costa Rica (both).
  - Authority and conditions to trigger should be clear (example: Switzerland — only a supermajority in Parliament; Poland — cannot invoke when debt exceeds 48 percent of GDP or deficit exceeds 3 percent of GDP).
  - For frameworks with multiple elements, clarify which element is suspended when escape clause is in effect.
  - Limit the size of allowed deviation:
    - Colombia: deviation up to 20 percent of the output gap.
    - Ecuador: allows 1 percent of GDP increase in primary expenditures.
    - Peru: allows the fiscal deficit to go up to 2.5 percent of GDP (against 1 percent rule).
    - Panama: allows the budget deficit to go up to 3 percent of GDP (against 1.5 percent rule).
  - Allowances can be adjusted depending on nature of shocks.
- Escape clauses should be designed carefully and clearly to avoid misuse and strengthen credibility (Dudine and others, 2019).

### Enforcement mechanisms and correction tools
- Formal enforcement mechanisms can help ensure ex-post compliance and strengthen accountability.
- Among 104 countries with fiscal rules, 72 have formal enforcement mechanisms (Davoodi and others, 2022).
- European use of the Excessive Deficit Procedure (EDP) to specify corrective actions and timelines for returning to rules; EDP details include:
  - Breach thresholds: maximum government deficit 3 percent of GDP and debt 60 percent of GDP.
  - Declaration of an EDP intensifies surveillance; not automatic given escape clauses.
  - Deadlines: six months (or three for a serious breach) to comply with recommendations; failure can lead to sanctions (fine of 0.2 percent of GDP) or temporary suspension of European Structural and Investment Funds for recipients.
  - Two Pack regulation (entered May 30, 2013) includes provisions for closer monitoring of member countries in EDP.
- Examples of correction mechanisms:
  - Swiss and German structural budget balance rules contain “debt brakes” where deviations are stored in a notional account triggering automatic improvements when thresholds exceeded (Budina and Kinda, 2013).
  - Poland: specified preemptive triggers as debt approaches fiscal rule limits (rule limits described elsewhere).
  - Peru, Panama, and Jamaica: have correction mechanisms guiding return to fiscal rules after deviations.

### Role and functions of independent fiscal institutions (fiscal councils)
- Fiscal councils can support compliance and better fiscal outcomes:
  - Evidence: Debrun and Kinda (2017) — better fiscal outcomes; Beetsma and others (2019) — accuracy of budget forecasts and better compliance; Capraru (2022) — better compliance; Chrysanthakopoulos and Tagkalakis (2022) — reducing procyclicality.
- Over 80 percent of fiscal councils in advanced economies had de-jure operational independence in 2021 (powers include appointing staff, own communication channels, long-term appointments).
- Independence often enshrined legally to limit political interference, especially for recently established councils.
- Key roles of fiscal councils:
  - Watchdog: evaluate public finances; examine annual and medium-term government budget proposals; assess long-term sustainability and fiscal risks; conduct ex-post evaluations of fiscal performance.
  - Forecasts: prepare or assess macroeconomic and budget forecasts. Examples where councils prepare forecasts: Brazil, Chile, Vietnam, Kenya, Colombia, Hungary (except Vietnam, forecasts not binding). Examples where councils assess forecasts by budget institutions: Mexico, Peru, Uganda.
  - Compliance: independently monitor implementation of fiscal rules (primarily in European countries and Latin America, including Costa Rica, Chile, Colombia, Brazil, Panama, Peru, Uruguay).
  - Costing: nearly half of fiscal councils involved in costing policy measures; deeper costing more common when councils are associated with legislative branch (examples: Parliamentary Budget Office in Greece, Georgia, Canada and Australia; Congressional Budget Office in the US; Office for Budget Responsibility in the UK).

### Designing a fiscal rule for South Africa — initial considerations
- Two-step process for designing a fiscal rule:
  - Step 1: calibration of a long-term fiscal objective (anchor). Anchoring to a stock variable (e.g., public debt) necessary because fiscal sustainability determined by government balance sheet and capacity to meet financing needs and service debt. Debt anchor should guide medium-term fiscal policy because debt stock not fully under government control.
  - Step 2: select operational rule to achieve long-term debt anchor. Operational rules can be based on fiscal indicators closely linked to debt dynamics (e.g., expenditure or deficit rules). Clear escape clauses, adjustment mechanisms, and supporting fiscal institutions (councils) are key.

Debt anchor calibration approach
- Following methodologies (Debrun and others 2019; Baum and others 2017; Eyraud and others 2018), calibrating debt anchor involves:
  - Estimate maximum debt limit based on macroeconomic dynamics.
  - Determine safety buffer around maximum debt limit taking into account past macroeconomic and fiscal volatility.
  - Long-term debt anchor = maximum debt limit − safety buffer.
  - Define intermediate medium-term debt objective as a step toward long-term anchor.

Conceptual notes on maximum debt limit
- Maximum debt limit: level beyond which fiscal sustainability jeopardized.
- Debt limits linked to debt carrying capacity, determined by institutional strength, access to financing, fiscal multipliers, size and depth of domestic financial market, etc.
- Debt limits vary across countries, but cluster around 60 and 70 percent of GDP for both national and supranational rules (IMF 2018).

Approaches to calculate South Africa’s maximum debt limit
- Debt limits with exogenous interest rates:
  - Comelli and others (2023) use a probit model estimating maximum threshold of interest-to-revenue ratio beyond which high probability of fiscal stress ensues; for South Africa this implies a maximum debt limit of around 73 percent of GDP.
  - Method estimating maximum debt limit associated with highest primary surplus a country can achieve in stress: IMF work used for Brazil (90 percent), Colombia (50 percent), Paraguay (50–70 percent). For South Africa, using a primary surplus of 2.5 percent of GDP (average achieved over 2000–07) suggests a range of debt limits of 60–100 percent of GDP, depending on whether (r-g) under stress is calibrated to South Africa experience or upper bound of EMs’ average.
  - Caveat: these methods treat interest rates as exogenous to debt levels, risking overestimation; higher debt could place upward pressure on interest rates via higher risk premiums or diminishing convenience yields (Laubach, 2009).
- Debt limits with endogenous interest rates:
  - Mian, Straub, and Sufi (MSS, 2022) framework defines maximum sustainable debt consistent with maximum primary balance a government can sustain, incorporating endogenous relationship between debt and interest rates.
    - For South Africa, assuming socially and politically sustainable primary surplus no more than 2.5 percent of GDP (achieved 2000–07) implies a maximum debt limit of 80 percent of GDP, assuming elasticity of interest rate to changes in debt at 2.5 percent.
    - Incorporating projected stock-flow adjustments further squeezes maximum sustainable debt level to around 70 percent of GDP.
  - Jian, Sargent, Wang, and Yang (2024) endogenous-interest framework links maximum primary balance to optimal taxes, where (r-g) influenced by probability of debt surge, convenience yield, and risk premium on GDP volatility; this method estimates South Africa’s debt limit at around 60–70 percent of GDP (Cao et al, 2024).

*Source: sipea2025024 - 11. While fiscal rules have generally been found to be associated with better fiscal outcomes,*

### 24. A more prudent debt anchor would ensure a high probability of not surpassing the maximum

### 24. A more prudent debt anchor would ensure a high probability of not surpassing the maximum debt limit

### Key simulation findings on debt ceiling and buffer
- Simulations of future deficit and debt trajectories use estimated distributions of macroeconomic and fiscal shocks based on historical data for South Africa and stochastic simulations under those shocks (fan charts shown in Figure 9).
- A buffer of 10 percent of GDP would reduce the probability of debt surpassing 70 percent of GDP in South Africa to less than 10 percent.
- A debt anchor of 60 percent of GDP is judged to be prudent over the long term and is consistent with debt rule limits/anchors set by other EMs (Figure 10).
- Assumptions applied in all simulations: maximum primary surplus of 2.5 percent of GDP (historic high) and no change in the currency composition of debt.

### Intermediate target and operational implications
- Setting an interim target can provide short-term operational guidance and lend credibility to the fiscal framework.
- Recommended interim target: reduce the debt-to-GDP ratio to 70 percent of GDP by 2030 as a step toward the long-term debt anchor of 60 percent of GDP.
- Benefits of ambitious and early implementation:
  - Improve fiscal credibility.
  - Start rebuilding fiscal buffers.
  - Reduce marginal interest costs via improved market access, with positive spillovers to private sector borrowing costs.

### Comparative and empirical context (fiscal rule adoption)
- Fiscal-rule adoption snapshot (Figure 11) — counts by rule type:
  - Budget balance rule: 93
  - Debt rule: 85
  - Expenditure rule: 55
  - Revenue rule: 17
- Out of 85 countries with debt rules, only five have a debt rule on a standalone basis; the rest combine it with other rules.
- Example of national tax cap: Australia’s tax to GDP was previously capped at 23.9 percent.

### Operational rules taxonomy and trade-offs
- Four broad categories of fiscal rules and key characteristics:
  - Debt rule
    - Offers clear link to ultimate debt target by setting an explicit ceiling on public debt (usually as percent of GDP).
    - Least controllable indicator because debt ratios are influenced by factors not directly under government control (e.g., interest rates, exchange rate, inflation, stock-flow adjustments).
  - Budget balance rules (BBRs)
    - Overall balance rule: simple, easy to communicate and monitor; can increase procyclicality and bias budget composition toward capital cuts.
    - Golden rule: excludes capital expenditures to avoid cutting public investment; risks excessive borrowing and weaker link to debt objective.
    - Primary balance rule: excludes interest payments and is more directly under policymakers’ control; requires recalibration to incorporate changing debt dynamics.
    - Cyclically adjusted/structural rule: adjusts for cyclical changes and better reflects discretionary effort; difficult to assess in real time.
  - Revenue rules
    - Set floors or ceilings on government revenues; seldom adopted standalone; may increase procyclicality or limit revenue mobilization depending on design; earmarking windfalls can mitigate bias.
  - Expenditure rules (ERs)
    - Fully under government control but weaker link to debt dynamics; typically set expenditure ceilings in levels, growth rates, or percent of GDP.
    - Associated with lower procyclical bias and lower expenditure volatility versus other rules, but can be linked to procyclical investment changes and higher income inequality in some evidence.

### Policy recommendation for South Africa’s fiscal-rule design
- Tighten the existing expenditure rule and combine it with a primary balance rule to help achieve the debt objective:
  - Calibrate the expenditure rule to ensure a minimum improvement in the primary balance required to achieve the debt target.
  - Avoid exclusions (e.g., SOE support) to strengthen the link with debt dynamics and make the rule transparent and easier to monitor.
  - In case of upside revenue surprises, save additional revenues or use them for debt repayments.
  - Limit mid-year adjustments to spending reappropriations; use contingency allocations when fiscal risks are carefully calibrated and accounted for.
  - The combination of an expenditure rule and a primary balance rule could be more effective than the current framework, allowing consolidation on both revenue and spending sides in a downside surprise.

### Transitional arrangements and implementation requirements
- Transitional rules could:
  - Guide the fiscal position toward a steady state.
  - Address the immediate challenge of reversing rising debt and reaching the intermediate debt target of 70 percent by 2030.
  - Put the trajectory on a firm downward path until reaching the 60 percent fiscal anchor, after which rules could be reviewed and recalibrated to stabilize debt at that level.
- Implementation prerequisites:
  - Strong public financial and expenditure frameworks to accommodate urgent and unforeseen expenditure through reprioritization.
  - Enhanced capacity to identify and secure decisions to make expenditure savings.
  - Strengthened long-term fiscal-forecasting capacity and reporting.
  - Strengthened fiscal risk management, including risks arising from SOEs.
  - Assign an independent institution to assess budget assumptions and report on the government’s adherence to its strategy to enhance accountability and credibility.
  - A sound legal framework consistent with medium-to-long-term fiscal and debt policy objectives, with specific provisions for enforcement and independent monitoring.

### Conclusion (summary)
- The current spending rule in South Africa did not prevent the rapid rise in public debt over the past decade.
- Under the current staff baseline, debt is not expected to stabilize over the medium term as unfavorable interest-growth differential and sizable stock-flow adjustments are projected to more than offset a modest consolidation in the primary balance.
- To reduce debt vulnerabilities, putting public debt on a downward path toward a lower, more prudent level is essential.
- Recommended fiscal framework elements:
  (i) a prudent debt anchor—estimated using a variety of methods, and accounting for a safety buffer—of around 60 percent of GDP in the long run, supported by an intermediate debt target of 70 percent of GDP in the medium run;
  (ii) a credible fiscal rule, which could build on and strengthen the existing framework of expenditure ceilings, and be complemented by a primary balance rule, including well-defined escape clauses in case of large unforeseen shocks; and
  (iii) assigning an independent fiscal body to assess the robustness of assumptions and report on implementation.
- Effective implementation requires a sound legal framework, strong supporting public financial and expenditure frameworks, and sound fiscal risk management practices.

*Source: IMF staff analysis in "24. A more prudent debt anchor would ensure a high probability of not surpassing the maximum" (sipea2025024).*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025024.pdf_