Things appear to be looking up for the South African economy.
Numbers released last week show growth is picking up speed. Covid-19 cases are declining and the lockdown was eased earlier this week, which has to be good for growth. Mineral exports have been surging and in the last quarter we ran a record current account surplus.
According to the Bureau of Economic Research, we might see growth of five percent this year, which would amount to a strong rebound from last year’s seven percent contraction. The current account surplus increased to 5.6 percent of GDP from 4.3 percent in the first quarter, a rare occurrence for a country that usually runs a deficit.
But South Africa still suffers from deep economic problems – low growth, rising government budget deficits and high debt, record high unemployment, and low investment. And it is far from clear how the country will embark on economic reform to generate stronger growth. Despite the rhetoric, there is no sign of any determination by the ANC to tackle our big structural problems.
While the strength of the Rand does show a degree of international confidence, the world still realises that we have deep economic problems and that urgency to reform is lacking. While domestic economic factors have some bearing on the exchange rate, the greater weighting on the currency is the outlook for emerging-market commodity producers.
Windfalls very often take away the urgency for tough economic decisions. Big business in South Africa shows no sign of putting the big reforms at the top of its agenda with government, and instead seems intent on just protecting its narrow interests. The big issues of expropriation without compensation and property rights remain unresolved. Other issues include the bureaucratic hurdle of black economic empowerment undermining the investment case for the country, the need to improve education, a change in the labour laws to stimulate job creation, and dealing with the state’s outsize deficit of 14 percent of GDP.
Crisis or ballot box
It increasingly seems that reform will either have to come through an economic crisis or the ballot box.
For the moment, we can forget about the International Monetary Fund (IMF) as a force for reform in the country. South Africa does not need to borrow from the Fund as it has high foreign exchange reserves, as pointed out by Dawie Roodt, Chief Economist at Efficient Group. The Fund is usually called upon when a country faces a critical shortage of foreign exchange. This often comes about due to a default on foreign debt by the government due to large deficits, its inability to sufficiently export, and its inability to borrow more. A large government budget deficit often fuels a trade deficit as demand for foreign goods rises. South Africa has an excessive budget deficit and many problems that impede growth, but it does not face a critical shortage of foreign exchange.
We face an unusual set of circumstances in not requiring an IMF loan despite a high budget deficit and unsustainable public debt. But above all, we do need the sort of reforms the IMF would bring to secure faster growth and make inroads into our economic problems.
Government is protected from having to go to the IMF by the Reserve Bank’s substantial holding of foreign exchange reserves. At last count, at the end of August, the Reserve Bank held foreign exchange and gold valued at $58.4bn, over 20 percent of GDP.
Unless its independence is compromised and it is compelled to do so, it is highly unlikely that the Reserve Bank will make its reserves available to the state to finance the deficit or service debt. Nevertheless, reserves do provide a cushion and confidence for buyers of South African government bonds.
Most government debt, about 70 percent, is held by locals, and close to 90 percent is denominated in Rand. That means there is a low risk that liquidity in the government bond market will dry up. And for foreigners who either hold rand or foreign currency-denominated bonds, that is a type of insurance, meaning they will be able to sell and take their money out.
Chance of default
The relatively low percentage of debt held by foreigners does not in itself reduce the chance of default. Local currency public debt defaults have been relatively common over the past 60 years, according to research cited by the Reserve Bank’s most recent Financial Stability Review.
The Reserve Bank has the job of ensuring market liquidity under its financial stability mandate, and hence can intervene with its reserves to ensure confidence is restored. When foreigners rushed out of bonds last year and the markets had to be calmed by the intervention of the Reserve Bank, it all ended well. South African debt provides a good yield, albeit at heightened risk due to the sizeable budget deficit.
Despite its financial stability mandate, the central bank could resist the idea of providing an unconditional bailout to the government, should a default threaten. The Bank would have to play some role, given its financial stability mandate, and discussions around this might be immensely difficult.
The wave of good economic news may well delude the government into thinking that deep change is not required. The leak of an ANC economic transformation committee document to the Sunday Times pointing out that the fiscus is short of R109 bn has given the message to the party that the government cannot finance crucial spending for which budget allocations have already been made if it has to back the ANC’s big ideas, such as a basic income grant and a state bank.
If public debt is to be sustainable, existing allocations must also be cut. With debt growing and the lack of political will to cut the public wage bill, public debt is unsustainable.
Reform driven by a crisis is far more likely than a pre-emptive approach to the IMF. When the US Federal Reserve starts to tighten its monetary policy, perhaps some time next year, foreign investors will see greater risk in holding emerging market debt. And that is when there is a risk of a run to sell our bonds. The prospect of that poses a risk to our financial system, as about 20 percent of South African public debt is held by our banks.
Threat to financial stability
With the increased risk of default, the Reserve Bank could say to banks that they should cut their holdings of government debt. The central bank can do so, but would potentially risk a run if it said that holding bonds is a threat to financial stability. But that could also show the government it is intent on remaining independent and will not bow to its demands to monetise the deficit, or print money. The Reserve Bank’s role will become increasingly precarious as dealing with our public debt situation takes on greater urgency.
The easiest political path would be reform through the ballot box, something akin to what could emerge as the Zambia solution. But that could be a long way off and is likely to involve much economic hardship before it happens.
The views of the writer are not necessarily the views of the Daily Friend or the IRR
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