REZA ISMAIL: Despite doomsday warning there is no chance SA will ‘run out of money’
Finance minister Enoch Godongwana was recently quoted saying SA is at risk of running out of money by March next year. While it is clear that the state of SA’s finances is dire, this statement is worth unpacking after the release of the medium-term budget policy statement (MTBPS).
“Running out of money” is a largely figurative expression that assumes a degree of economic sophistication on the part of the receiving audience. It is dangerous to use this phrase when there is a risk that the expression could be taken literally, since for most sovereigns the idea of literally “running out of money” is technically impossible.
The finance minister’s comments should be seen in the context of ballooning national debt and the reality that debt servicing will become an increasingly punitive burden in an environment of low aggregate demand and economic activity.
The release of the MTBPS highlights this clearly. The finance minister has indicated that on the current trajectory SA will miss its annual revenue target by R57bn in the current fiscal year, and by R54bn in 2024 and R68bn in 2025, unless new sources of revenue are found. Further to this, the Treasury expects gross government debt to stabilise at 77% of GDP by 2025/26.
Over the next three years debt service costs as a share of revenue will increase from 20.7% in 2023/24 to 22.1% in 2026/27. For every R5 in revenue, more than R1 is being used simply to service debt.
With aggressive cuts in a number of key budget items the term “running out of money” is being bandied about, but what does this actually mean for SA government finances? A more accurate term would arguably be “debt monetisation”, the technical term for printing money.
“Debt monetisation” is a permanent increase in the monetary base with the aim of funding government. In other words, debt monetisation occurs when central banks buy interest-bearing debt with non-interest-bearing money.
The requirement that it be a permanent exchange of debt for cash is critical. Monetisation is not a simple open market operation by a central bank, which is frequently conducted to achieve policy targets. Arguably, this where the discussion around the independence of the SA Reserve Bank is such a contentious subject between the public and private sectors.
There has been much discussion around whether the quantitative easing (QE) programmes that have been in effect in developed countries in particular for much of the past decade — and in some cases were relaunched during the Covid pandemic — should qualify as debt monetisation.
While central banks undertaking QE have maintained some separation from directly funding government deficits through purchasing assets in secondary markets, this distinction is superficial at best, since large scale central bank buying has helped governments borrow at ultra-low rates.
While QE programmes over the past decade have led to an increase in the monetary base, they have done little to increase money supply in the mainstream economy. This was partially due to central banks paying interest on reserves at the central bank, and a reluctance on the part of banks to lend during the period immediately after the 2007 global financial crisis.
Rather than the focus on the comments around running out of money, we should be zeroing in on the finance minister’s comments over the lack of appetite for our bonds despite the attractive yields they offer.
There is no question that yields on SA bonds represent great value on paper, and there are many who comment that “lack of appetite” has to do with doomsday predictions for SA as a country. Rather, we think it all depends on what the opportunity cost of capital amounts to in the developed world relative to SA.
In the aftermath of the global financial crisis this “opportunity cost” was essentially zero, because policy rates in the developed world were zero. This dynamic has now changed. The US economy, which continues to surprise to the upside with regard to the strength of households, has seen long-dated bond prices repriced weaker, which is resulting in higher yields.
Since real yields in the US have largely repriced due to a revision in growth prospects and resilient consumption, this would ordinarily be met by US and foreign capital “seeking out” risk-assets in pro-cyclical destinations — emerging markets such as SA.
However, to date this has not happened, because the stronger US labour market has in some sense “cross-subsidised” the federal open market committee’s resolve to keep policy rates “higher for longer”, and in so doing made the front-end of the US term structure an attractive investment destination.
So, even though conditions are aligning such that the bull case for SA bonds — and risk assets globally in general — has grown stronger, the actual experience in the SA bond markets has been contrary to expectations.
The heart of the matter is that as the stronger US economy grinds on, the longer the risk-free front-end of the US curve can afford to remain elevated, and this creates a high hurdle to scale before capital will look for yield elsewhere. The opportunity cost of moving away from the US is simply too high at present.
SA is not in danger of “running out of money”, but debt-servicing costs are rising and this is taking money directly out of the hands of the most vulnerable, which could have dire long-term consequences. The country will need to adopt growth-focused policies if it is to turn the tide.
• Ismail is head of bonds at Prescient Investment Management.
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