Teetering dominoes of SA’s state entities
Ratings agencies have been warning for some time that the biggest risk to the country’s public purse, and to its ratings, are the “contingent liabilities” that result from the guarantees the government has given to state-owned enterprises (SOEs).
Equally, Treasury officials have been worried about the risk of contagion if even one of those SOEs defaults on a loan agreement. Those risks have come disturbingly close to materialising in the past couple of weeks. SA has been saved for now, but it may not be again — at least not without serious efforts to sort out the mess at the SOEs.
A first sign of trouble came in June when Standard Chartered refused to roll over its R2.3bn loan facility to South African Airways (SAA), forcing the Treasury to pay up to avoid a default that could have resulted in all the other lenders to call in the guarantees to SAA.
But the real trouble came when Eskom’s auditors SizweGobodoNtsaluba issued a qualified audit opinion on the power utility’s financial statement. The qualified audit was a disgrace for Eskom’s board and management.
And as Stuart Theobald and Simon Mantell have suggested on these pages, the irregular R3bn the auditors have cited is likely to be just the tip of the iceberg.
But the qualified audit also breached covenants that were written into two of Eskom’s large loans – from the Development Bank of Southern Africa (DBSA) and development funder Agence France de Developpement (AFD) – which meant Eskom was technically in default on those loans.
As we now know from media reports, the DBSA protested strongly about Eskom’s governance but was persuaded not to call the default, as presumably was the AFD.
Had those funders called the default, as they were entitled to, the SOEs and their shareholder could have fallen like the proverbial house of cards. The main reason is the cross-default clauses written into the other bond and loan agreements Eskom and other SOEs have with their funders.
That would mean that one default would have forced other bondholders and lenders to call defaults on their loans. And the domino effect would not have been confined to Eskom but could have spread to other SOEs such as Transnet or the South African National Roads Agency Limited if their bonds contained cross-default clauses triggered by a default by any of the SOEs, or by the government itself.
The concern about such contagion had already come up when Standard Chartered refused to roll over the guaranteed loan facility to SAA and the government had to cough up. But where SAA has about R20bn of government guarantees, Eskom is the megaborrower, with about R220bn in guaranteed debt and a further R140bn in unguaranteed debt.
And there are layers of complexity involved: some loans are guaranteed, others are not; some bonds are in local currency, others are in foreign currency, with the kind of onerous terms typical in the US, for example.
And there is a whole spectrum of default and cross-default clauses in the many different debt instruments SOEs have.
The most immediate risk – and the one flagged by ratings agencies – is that the government guarantees would be called. That doesn’t mean the government would have to pay back the money. Rather, it means the government would have to take the debt onto its own balance sheet and pay the interest.
Government debt is already at about 50% of GDP. S&P Global Ratings estimates SOEs’ use of guarantees is about 10% of GDP, of which 7% is Eskom alone. So if all those guarantees were called, the government debt ratio would ratchet up to at least 60%. If the dominoes started to fall and the guarantee facilities the government has in place were drawn on, it could go much higher, potentially to what the IMF calls a dangerous level of 70%. In a situation of default, no one would be funding SOEs without a guarantee, if they were willing to fund them at all.
Either way, the ratings agencies’ number one risk would have been realised and a downgrade would follow within months, if not weeks. This time, it would be the local currency rating that would be downgraded, triggering potentially huge capital outflows by foreign index funds invested in Citi’s World Government Bond index, weakening the rand, putting pressure on interest rates, cutting growth further and potentially causing instability in the financial system.
The big question is how much of the risk the ratings agencies have already taken into account in their ratings.
If all of it is already priced in, as it were, a local currency downgrade is not inevitable unless things get a lot worse, as they certainly could.
For now, the important point is that Eskom’s lenders did not call a default — no one in the market wanted to see that happen — and the house of cards is intact. But given what could have happened, chances are that no responsible banker or investor is going to offer any new money to any of the SOEs without tough conditions and high costs.
The pressure will be on for the government to install professional, competent, credible boards and managers with which funders are willing to work.
THE MOST IMMEDIATE RISK — AND THE ONE FLAGGED BY RATINGS AGENCIES — IS THAT THE GOVERNMENT GUARANTEES WOULD BE CALLED
Joffe is editor-at-large.