Beating the borrowing habit will be hard

In its response to the downgrade of SA’s credit rating to “junk”, the Treasury calls for reduced reliance on foreign and local borrowing. It notes that only 10% of government’s R2.2-trillion debt is denominated in foreign currency. The rest is rand-denominated.

SA should, the Treasury suggests, reduce its dependency on foreign savings and rely less on debt to fund government spending to “secure SA’s fiscal sovereignty and economic independence”. Similarly, Finance Minister Malusi Gigaba warns “it is essential that SA relies on her own resources, and that government lives within its means”.

This advice is sound, because the costs of foreign and local borrowing will rise significantly following the downgrade. However, it sidesteps how difficult weaning SA off its very high reliance on borrowing will be.

For more than a decade, the country has consistently spent more than it produced. The resultant deficits with the rest of the world were funded by foreign capital inflows.

At its highest, spending exceeded output by more than 6%. In 2016, this gap fell to 3.3%. Even at this reduced level, SA requires R140bn in foreign capital inflows every year, just to sustain current levels of government and private spending.

Only a small portion of these inflows was the result of direct borrowing by the government from abroad. The largest share came from foreign savers buying shares in SA’s listed companies and government bonds. They paid for these in foreign currency. It is these purchases that are now at risk following the downgrading of SA’s creditworthiness to junk.

Reduced foreign purchases of SA’s rand-denominated bonds will have painful consequences. It will raise the cost of funding the government’s large budget deficit. In 2017, 11c of every rand the government spends goes to meet interest on its debt. Higher interest rates will raise this further, reducing funds available for existing spending commitments.

Even more significantly, there will be no scope for new spending. Politicians may make promises, but there will be no way to fund them.

In the absence of further foreign funding, either output needs to rise, or spending must contract.

While the Treasury wants to focus on growing the economy, meaningfully faster growth is now highly unlikely. Investor confidence, which was already low, has been battered by the assignment to junk status.

Reducing spending in these now-constrained circumstances will be very painful. It will be forced upon us mostly because a weaker rand will drive up prices. Possibly, the Reserve Bank will now also be compelled to raise interest rates.

In the last years of apartheid, SA was forced to run without foreign capital when financial sanctions brought the economy to its knees. The economy grew by less than 1% per year for a decade. As a result, unemployment soared, living standards plummeted and the government’s deficits and debt escalated as tax revenues stagnated.

Because it recognised the enormous burden a lack of foreign capital places on economic growth, SA’s first democratic government worked very hard to open access to global capital markets — including obtaining credit-grade status.

Such access has been seriously damaged but not entirely blocked by the credit downgrade. The country will still be able to attract foreign capital, but in smaller amounts and much more expensively. Care has to be exercised in using future funds far more productively than in the past.

It will be hard enough to cope with scarcer, more expensive foreign inflows. What SA absolutely cannot afford is to provoke further investor anxiety and large outflows, sparked by reckless rhetoric and policies aimed at short-term political gain.

Foreign ownership in SA’s equity and bond markets, as well as direct investment, amounts to trillions of rand. The effect of widespread selling and removal of such funds from the country would be devastating.

Much damage has already been done. The new finance minister has a huge responsibility not to stoke the fires further.