In SA, Covid-19 just made things much worse
SA’s fiscal position is precarious. Debt stock more than doubled from 26% of GDP in 2008 to a pre-pandemic level of 65.5% in 2020. The Covid-19 crisis has pushed this to about 80%.
The dynamics at play, including a now-large stock of debt, low rates of nominal growth, excessive expenditure relative to revenues and stubbornly high borrowing costs, mean that SA may not be able to contain the rise in debt and that the cost of servicing it is likely to become overwhelming.
There are active market debates about the ultimate risk of default. Assuming past trends remain unchecked, this is a real risk.
In SA, debt service costs have been compounding at a rate of 12.6% over the past six years, while nominal growth has been compounding at 6.2% over the same period.
Part of the problem is that SA’s fiscal position has been deteriorating for a long time. This isn’t just a “Covid-19” deficit and debt surge, as is the challenge in many other countries. Covid-19 just made things much worse.
SA’s borrowing cost is higher than just about anywhere.
The Covid-19 shock brought a step change to most governments’ fiscal positions around the world. A huge combination of tax, income, health and poverty support, coupled with a collapse in revenues, saw global government deficits balloon in 2020. The effects are expected to linger in coming years as policy support is withdrawn at a staggered pace, and large deficits will need to be funded.
Conventional financing options for such a large fiscal shock are limited. Governments usually have two basic ways in which to finance deficits: raising taxes, or borrowing and raising debt. However, given the sudden need for huge funding, a third, less conventional option has also become popular: central bank financing.
The official wording around these interventions is broadly consistent, though scope and design vary by country. With policy rates at or close to zero, the broad aim is for a central bank to use its balance sheet to increase demand for government debt to meet the increase in supply, providing funding, creating broader liquidity, lowering borrowing aggregate costs, and encouraging credit lending and growth.
Most developed economy central banks have implemented policies with these broad objectives. According to the IMF, 27 emerging market central banks (including SA) also implemented successful asset purchase programmes during 2020. Some of these interventions were short-lived, while others have been extended, facilitating lower funding costs.
Unsurprisingly, there are ongoing calls for the SA Reserve Bank to reinstate the asset purchase programme it used in mid-2020, hopefully to achieve the same effect. The Bank has provided little financial support to the government through the crisis, and it seems reasonable that there is capacity to do more. While the government has drawn down deposits with the central bank, the government still holds cash and other deposit buffers with the Bank.
However, it is deeply uncertain whether such an intervention could successfully and sustainably lower the cost of funding, and here’s why — the countries where these programmes have achieved lower long-term interest rates share at least some common features:
- The institutions involved are deemed credible by markets.
- The related policies (monetary interventions and stepped-up fiscal support) are deemed to be finite. This is not seen as open-ended funding.
- Prevailing inflation is low.
- Generally, in emerging markets:
- the starting stock of debt is low, and governments are seen to have some fiscal headroom; and
- foreign positioning is small, and the local (often state-owned) banking sector is a large owner of government debt.
- Pre-crisis growth rates were good (which means the ability to recover is implicit).
What makes this challenging for SA is that we share two of these requirements. We have low inflation and a credible central bank. As mentioned, the country’s fiscal deterioration is not just a function of the effect of the pandemic; it is the accumulation of years of weak fiscal and economic performance, which means our starting position is fragile and fiscal credibility is poor.
This means that neither the government nor, presumably, the central bank, can commit to a “finite” intervention — and the market knows it. Because of this, any intervention wouldn’t look like a “Covid-19 funding strategy”; it would more likely reflect a central bank that is funding infinite issuance by a government previously unable or unwilling to effectively manage expenditure. The Bank’s important credibility would easily be lost.
With still-heavy foreign positioning (foreigners own 29.9% of marketable SA bonds), it seems likely that such action would cause foreign investors to divest and stay away, sharply weakening the currency.
This policy option is also unappealing from the Bank’s perspective. Unlike many of the countries referenced here, policy rates in SA are not at a lower bound. At 3.5%, the Bank could cut further if it were deemed appropriate. With the market functioning normally — albeit at elevated yields — and the Treasury on a comfortable cash cushion for now, there is little need to intervene to ensure financial stability.
Further, high yields are a reminder to the government of the cost of its profligacy, and the need to reform. Governor Lesetja Kganyago has said before that the Bank will not take responsibility for solving the problem of fiscal sustainability, and certainly not at the risk of its hard-won credibility.
There are also other ways to help lower borrowing costs, including a more flexible funding strategy. The government has already lowered the average cost of borrowing in 2020 relative to the previous year by issuing more treasury bills closer to low policy rates and using low-cost foreign loans.
This is not a feasible strategy for many emerging markets, but in SA’s case, with a long period of prudent asset and liability management and the long average maturity of its debt stock predominantly in local currency, it could implement this strategy comfortably for a limited period. The introduction of other financing instruments, with flexible rates and maturities that fall between the large bond issues, may also take pressure off the overall financing bill.
Until the underlying inhibitors to lower funding costs are decisively managed, investors will remain concerned about the sustainability of the fiscal position, and will price associated risk appropriately. It may well happen that markets lose faith in the government’s ability to service its debt in full and on time, and, in the event of a financial crisis, the Bank will have to step in.
But the durable solution is a permanent consolidation of the deficit and a visible improvement in domestic growth outcomes.
• Antelme is an economist at Coronation Fund Managers.
Would you like to comment on this article or view other readers' comments?
Register (it’s quick and free) or sign in now.
Please read our Comment Policy before commenting.