Hazards in tapping Bank’s reserves
• S&P warns that accessing reserve account could fuel inflation
S&P Global Ratings has cautioned that the government’s decision to access the paper profits on SA’s gold and foreign exchange reserves could fuel inflation and put the Reserve Bank’s independence at risk unless the money is carefully managed and subject to strict rules.
The ratings agency also warned that tapping the profits could encourage “moral hazard” or lead to spending increases that could be hard for the government to reduce.
“Although the practice of using unrealised valuation gains on foreign exchange is not unusual among developed and emerging economies ... it is relatively uncommon globally and could expose the country to risks on the monetary front,” S&P primary credit analyst Zahabia Gupta said in report on Wednesday. “This plan is a convenient but limited and temporary solution to the country’s long-standing fiscal challenges, in our view,” she said.
S&P’s comments come after finance minister Enoch Godongwana announced in his budget last week that the government would tap almost half of the R507bn of unrealised profits housed in the gold & foreign exchange contingency reserve account (GFECRA). It will use R150bn of the profits to reduce its steep borrowing requirement over the next three years, and transfer a further R100bn to the Reserve Bank to strengthen its balance sheet to help it meet the costs of transferring the money so as not to fuel inflation.
The gains on the GFECRA have risen steeply over the past decade as the rand has depreciated and the gold price has risen. Godongwana said the R150bn would slice 1.8% off the government’s debt ratio by 2026 and reduce its borrowing costs by R30bn.
S&P said the transaction would also provide some relief on domestic capital markets, which would see relatively fewer debt issues. “Fewer issuances would help reduce yields and free up capital for private sector lending”, it said.
However, one key risk was higher inflation: “The monetary expansion resulting from the transfer of unrealised profits could add inflationary pressures.” That could become more of a problem if the Bank came under recurrent pressure to finance higher budgetary
requirements — though this was not its baseline expectation, the ratings agency said.
Another risk was that the unrealised profits could turn to losses, leaving the Bank in a negative equity position. The R100bn set aside for the Bank will provide for it to maintain adequate buffers to absorb exchange rate swings but it was unclear how this would be calculated, S&P said.
It also warned of a loss — or perception of loss — of central bank independence.
“Granting access to unrealised profits could politicise the [Bank] and prioritise fiscal needs over broader monetary and economic stability,” S&P warned, though it noted the Bank was independent and had a record of maintaining low inflation.
The move to tap the GFECRA was generally well received, with market players hailing the fact that the government plans to use the money to reduce its borrowing rather than increase its spending. But the cautionary notes sounded by S&P chime with those of other economists who have warned that the GFECRA is neither a durable nor a risk-free solution.
Standard Bank economist Elna Moolman said in a note it was disappointing that the government planned a large, immediate withdrawal before it had put legislation in place to ensure its future use would remain prudent. The budget had provided only guiding principles on how the funds would be used, undertaking only that these would eventually be formalised through legislation, she noted.
Wits University’s Michael Sachs told parliament on Wednesday that deploying the GFECRA was one way of mobilising the public sector balance sheet to soften the blow of austerity. However, it could not resolve the underlying macrofiscal crisis and if badly managed, it could “add new risks and problems of financial stability to the government’s long list of development headaches”.
RMB Morgan Stanley has calculated that SA’s banking system will improve its profitability by 0%-3% as a result of the open market operations the Bank will use to sterilise the GFECRA inflows, which will be injected into the economy via reserves at the commercial banks.