Short-end borrowing risks a nosedive
Another week passes, and there is another credit downgrade. It ’ s not a good trend for SA, and talk of aid from the IMF and other bodies is becoming more conventional by the day.
The latest judgment on the country, this time by Fitch Ratings, wasn’t particularly surprising and the reasoning was more or less identical to that offered by Moody’s Investors Service when it downgraded SA a week before.
The economy isn’t growing and the country is borrowing too much, with no prospect of an improvement soon. If anything, the numbers painted an even more ugly picture than those of Moody’s.
When writing up the reports, the agencies certainly do not beat about the bush. “The downgrade of SA’s ratings is a result of the lack of a clear path towards government debt stabilisation as well as the expected impact of the Covid-19 shock on public finances and growth,” reads the first line of the Fitch report. It maintained a negative outlook on SA because of “further significant upside pressure on government debt and additional downside risks associated with the global shock”.
Fitch now sees the 2020/2021 fiscal deficit surging to 11.5%, which is higher than the Moody’s projection of about 8.5%. That’s even worse than the forecasts of some of the more pessimistic private sector banks, which see the deficit going to 10%. Fitch then sees the gap narrowing to 8% a year later.
This, in a context in which it expects GDP to shrink 3.8% in 2020 and grow 1.7% in 2021, translates to a debt-to-GDP ratio of 80.2% in 2022. Fitch, which dropped SA to BB, the second step into junk, says the median for similarly rated countries is 46.5%. To be told you are among the worst in a group of underperformers hurts.
In 2009 SA’s debt as a proportion of GDP was less than 25%, a legacy from the “1996 class project” of Thabo Mbeki and Trevor Manuel that has been well and truly squandered by their Polokwane successors.
BAILOUT
Thanks to those wasted years, SA is now not in a position to respond to the crisis as aggressively as has been seen in other markets.
While other countries are throwing in vast amounts of fiscal and monetary stimulus, we are debating how long we can stick it out before we go begging to the IMF.
Our deficit is fast approaching levels that saw the weaker eurozone countries being bailed out a decade ago. When Portugal applied for its bailout, the difference between what it was spending and collecting in taxes was just over 9% of GDP. That was still not too terrible compared with Greece, which had a gap of about 15% in 2009, and even Ireland, with more than 30% after bailing out its banks.
The help they received came with such conditionality that if replicated would have those who described finance minister Tito Mboweni’s February budget as an austerity one eating their words. Ireland was given four years to get that budget deficit down to 3%.
On the plus side, all three have shown various degrees of recovery and before long Ireland was the fastest-growing economy in Europe. Maybe tough medicine from the IMF might be good for us too if Cosatu have its way. Except that the political disruptions would be a lot worse and our democracy might not survive.
Of course, SA is different. For one thing, having our currency depreciate massively in the past month should, in theory, help boost growth and government revenue when the world starts trading again.
What is harder to explain away is the level of interest we are paying to borrow in financial markets. The troubled economies in southern Europe were shut out of markets when yields in double digits were deemed unsustainable.
Before the Reserve Bank’s intervention in March, SA 10year bond yields, which move inversely to the price, shot up to records above 12%. They are still too high, and not a good starting point if we are going to be tapping the market for more to fund our ever-expanding deficits.
BORROWING PROFILE
One short-term “solution” gaining traction in the market is that the government should change its borrowing profile and favour the short end. It does seem to make sense. It’s more expensive to borrow for longer because of the need to compensate the lender for duration (interest rate) risk, so the government could cut costs by reducing the maturity of its bonds
If FirstRand CEO Alan Pullinger is right, for example, that the Bank is behind the curve and will cut rates by another 75 basis points in 2020, then it should become even cheaper for the government to borrow on the short end.
There must be a catch — there is always one when an easy and tidy solution presents itself. SA would be chipping away at what Fitch describes as one of its remaining strengths, and a reason it doesn’t expect “acute problems in fiscal financing”. Other than that we owe most of our debt to ourselves and 90% of it in our own currency, we also benefit from the “unusually long average maturity of government securities”, which Fitch puts at 15 years.
Among the reasons the euro-area countries found themselves in deep trouble was the need to keep going back to the market to refinance themselves when short-term debt matured at a time of extreme turbulence, exposing themselves to the risk that they might not get market support to replace maturing debt.
Ultimately, as Absa Investment Management’s James Turp put it last week, the way to reduce funding costs is “by issuing less and by improving your economy”.