The IMF’s R70bn loan for SA: the pros, cons and potential pitfalls
The International Monetary Fund has approved a R70bn ($4.3bn) loan for SA to help the country manage the immediate consequences of the fallout from Covid-19. The Conversation Africa’s editor, Caroline Southey asked University of Pretoria Prof Danny Bradlow* to shed some light on what South Africans should expect
What conditions has the IMF attached to the disbursement?
The IMF has provided the funding through its Rapid Financing Instrument. This is designed to support countries facing an urgent need for financing due to a crisis such as the Covid-19 pandemic. The goal is to help the country face the immediate financial consequences of the crisis. As a result the IMF provides the financing quickly and without strict conditions.
The country merely needs to show the IMF that it is facing a crisis, that it will use the funds to deal with the crisis and that it will co-operate with the IMF to solve the balance of payments problems caused by the crisis, as well as to describe the economic policies it proposes to follow.
In some cases, the IMF may require the country to undertake certain policy actions before it can get access to the funds.
In SA’s case, the country’s payments problem relates to the fact that the economy is expected to contract by about 7% this year and that the budget deficit is set to rise to about 15% of GDP. This means the government will need to increase the amount it has to borrow. Given that it has been downgraded by credit ratings agencies and that the economy is in bad shape, there is a substantial risk that both local and foreign investors will have a limited appetite for SA debt. This will complicate the government’s efforts to finance the deficit.
The IMF loan helps resolve this problem.
SA provided the requisite information to the IMF in the form of a letter of intent signed by the minister of finance and the governor of the Reserve Bank. The letter has not yet been made public. But according to the IMF press release SA seems to have informed the IMF that it intends to take certain steps to stabilise the country’s finances.
This means the government will cut spending to reduce its need to borrow. The current disputes over public sector wages and funding for state-owned enterprises point to examples of steps it could take.
The government has also said it will improve the governance of state-owned enterprises and introduce reforms to stimulate a growing and inclusive economy. These reforms could include measures to improve competition in different sectors of the economy.
SA made these undertakings in last October’s medium-term budget statement and in the supplementary budget statement in June this year. This suggests the IMF is merely expecting the country to implement the policies already announced by the government.
How will the money be disbursed?
This kind of financing is provided in one payment. The IMF press statement doesn’t say when the funds will be disbursed but the goal is to make the funds available “rapidly”. That could be as early as August.
Once the money has been disbursed, the government will be free to spend it.
According to the National Treasury’s statement, it plans to use the money to support health and frontline services, protect the vulnerable, drive job creation, support economic reform and stabilise public debt.
These are all consistent with the purpose of the Rapid Financing Instrument and the government’s stated intentions. But these purposes are stated in very general terms, and we will need to see more detail about what exactly the government will spend the funds on.
What restrictions are there on the government’s ability to use the money?
The IMF loan does not impose any conditions over and above what is in SA law on how the funds can be used. Consequently the funds will be subject to the same procurement and accounting requirements as all other budgetary expenditure.
In addition, the government will have to account in its future budget statements and reports to parliament on how the funds have been used.
South Africans will also be able to demand that the government demonstrate that the funds have been spent consistently with the requirements of the constitution and the bill of rights.
This means the government should show that it is using the maximum available resources, from whatever source, to help realise all the rights that the constitution and SA’s international commitments grant.
The IMF requires that SA repay the funds to the IMF over 20 months, beginning 40 months after the loan is disbursed. This means that the funds to repay the IMF are properly budgeted for.
What are the upsides of the loan?
The most important benefit is that SA is getting $4.2bn at about 1.1% interest. It is a very cheap source of funds. If the government tried to raise the same amount either on domestic markets or from other international sources it would pay a considerably higher interest rate — the current rate for government bonds of comparable maturity is about 7%.
The second potential benefit is that the IMF loan will catalyse other funds for the country. In other words, investors in SA and abroad will interpret the IMF’s action as an expression of support for the country, and this will give them the confidence to invest in SA debt.
Given that foreign investors hold about 30% of the SA government’s rand-denominated debt this boost to confidence could be important. It will both reduce the incentive of these investors to sell their government bonds, potentially pushing up interest rates, and enable the government to issue new debt if needed.
The third benefit is that by helping to stabilise SA’s situation, it will limit the damage that may be inflicted on the neighbouring countries. This, in turn, could help SA exports and thus help preserve jobs and income.
What are the downsides?
The most significant downside is that the loan is denominated in foreign exchange.
Thus, SA has to bear the risk that if the rand depreciates, the loan and the interest on it will become more expensive. Given the state of the SA economy this is not an insignificant risk.
But it’s important to keep in mind that the IMF denominates the loan and the repayment obligations in Special Drawing Rights. These are the IMF’s special form of money and its value is made up of a composite of a basket of currencies. These include the US dollar, the euro, the Japanese yen, the Chinese renminbi and the pound sterling.
The values of these currencies tend to fluctuate against each other so that some appreciate while others depreciate. This helps mitigate the foreign exchange risk.
The second risk is that if SA does not use the funds from the IMF wisely, the country’s economic situation will deteriorate and it will struggle to pay back the debt.
If this happens, or if the pandemic lasts longer than foreseen, the country could be forced to seek additional support. In either case SA’s negotiating position would be significantly weaker.
*Bradlow is SARCHI Professor of International Development Law and African Economic Relations at the University of Pretoria. This article was first published by The Conversation Africa
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