IMF WARNS OF THOUGH ECONOMIC TIMES AHEAD
The International Monetary Fund reports this week that despite that Swaziland has a middle-income status, structural impediments have hindered private investment and kept unemployment high, contributing to persistently elevated poverty and income inequality. Macroeconomic conditions have recently deteriorated. In 2016, two shocks – a prolonged drought and a sharp decline in Southern African Customs Union (SACU) receipts – severely hit the economy, while an expansionary fiscal policy worsened fiscal and external balances. Growth in 2016 stagnated, as agricultural productions declined, and headline inflation increased sharply, mostly due to rising food prices. Government’s policy of increasing public expenditure, while SACU revenues declined, widened the FY16/17 deficit to about 10½ per cent of GDP. Public debt rose and domestic arrears accumulated, while the current account deteriorated and international reserve coverage declined below three months of imports.
The economic slowdown and government’s domestic arrears have started having adverse effects on the banking sector’s asset quality, with non-performing loans (NPLs) rising. Fiscal policy remains on an expansionary course, while the monetary stance has tightened. Despite a pickup in SACU revenue, the 2017 budget envisages a continuation of large fiscal deficits, and further increase in public debt. In the context of the peg to the South African rand, in early 2017 the Central Bank of Swaziland raised its policy rate above South African Reserve Bank’s rate.
On September 1, the Executive Board of the International Monetary Fund (IMF) concluded Article IV consultation1 with the Kingdom of Swaziland. Since the 2010 fiscal crisis, Swaziland has experienced a period of macroeconomic stability and recovery. A rebound in SACU revenues, expansionary policies and the peg to the South African rand have contributed to the rebuilding of buffers and supported a growth recovery. The outlook is fragile, with an unsustainable fiscal policy. Growth is projected to pick up in 2017 due to the end of the drought and increasing SACU revenue, and turn negative thereafter as fiscal and external positions weaken. The large fiscal deficit would contribute to further reduce international reserves and bring public debt above sustainability thresholds. Downside risks dominate the outlook. The main risk stems from further tightening in budget financing. Additional risks arise from deteriorating banks’ asset quality, lower SACU revenue and demand for key exports. With a fragile outlook, the materialisation of risks could trigger abrupt fiscal adjustment. Linkages between domestic financial institutions and the government could further amplify the negative impact of shocks on the economy.
Executive Directors noted that while Swaziland had experienced sustained growth and macroeconomic stability in recent years, the country is now facing formidable challenges.
A prolonged drought, and a sharp decline in SACU revenues have recently hit the economy. An expansionary fiscal policy has further worsened fiscal imbalances and created tighter links between the government and domestic financial institutions, contributing to the fragile economic situation.
In addition, Directors noted that structural impediments have kept growth relatively low. They emphasised that implementation of sound policies and structural reforms will be key to managing the rising risks, maintaining macroeconomic and financial stability, and generating stronger growth to reduce poverty and income inequality.
Directors emphasised that significant fiscal adjustment is needed to ensure macroeconomic stability and debt sustainability. They stressed that, with tightening budget financing, adjustment efforts should be spread over time and focus on both revenue and expenditure measures that can support long-term growth. Directors underscored that steps to contain the public wage bill, prioritise capital outlays, reduce transfers to extra-budgetary entities, and boost tax revenues will be critical to the adjustment effort. They encouraged the authorities to improve budget formulation and expenditure controls, and strengthen the governance of extra-budgetary entities to ensure the credibility of consolidation plans. Directors noted that strong fiscal adjustment will help release pressures on monetary policy. They underscored that the Central Bank of Swaziland (CBS) should refrain from additional budget financing and, in the context of the peg with the South African rand, the CBS should maintain the policy rate at a positive spread with the South African Reserve Bank’s rate.
Directors welcomed the authorities’ plans to amend the CBS Act to bolster the central bank mandate and independence and strengthen its supervisory structure. They stressed the importance of monitoring and assessing financial stability and macro-financial risks arising from tight linkages between government and the financial sector, and systemically large non-bank financial institutions. In this context, Directors recommended to accelerate plans to create a financial regulatory architecture and enhance the CBS’s capacity to assess macro-financial risks and exercise
Directors emphasised that bolder structural reforms are needed to foster stronger and more inclusive growth. They highlighted that the reform effort should focus on reducing skill mismatches through improving access and quality of higher education, aligning wage and productivity dynamics, including by containing public sector wages, and simplifying business regulations and improving the institutional environment. Directors welcomed the authorities’ recent increase of cash assistance programmes and suggested further scaling up and better targeting to address extreme poverty.
Swaziland is a small middle-income economy particularly exposed to external shocks and with significant structural challenges. After a sharp decline in revenue from the SACU in 2010 that prompted a fiscal crisis, revenue bounced back, fiscal and external balances improved, and buffers were rebuilt. The peg to the South African rand contributed to moderate inflation, and growth recovered. However, growth has been low compared to the pre-crisis period and other middle-income countries.
The current account remains heavily dependent on SACU revenue and exports concentrated on a few products. More recently, an expansionary fiscal policy has depleted buffers, leaving international reserve coverage below adequate levels and prompting a rapid increase in public debt. Moreover, despite its middle-income status, Swaziland faces widespread poverty and a high HIV prevalence rate. Unemployment remains high and little responsive to growth, contributing to elevated income inequality. In 2016, a prolonged drought and a sharp decline in SACU revenue severely hit the economy. Real GDP stagnated (1.1 per cent in 2015) as agriculture and hydro-power production declined because of the drought, with negative effects on other sectors of the economy. Declining private demand largely offset the impact of an expansionary fiscal policy. The decline in SACU transfers (about 4¼ per cent of GDP), coupled with strong demand for imports and lower exports (particularly for agricultural products), reduced the current account surplus to ¾ per cent of GDP (10.8 per cent of GDP in 2015). On the positive side, the net international investment position improved somewhat, although mainly reflecting short-term trade credit assets. However, other buffers have thinned, and end-year international reserve Swaziland, with Lesotho, Namibia and South Africa, is member of the Common Monetary Area (CMA), and its currency is pegged at par with the South African rand. CMA members and Botswana constitute the SACU. In recent years, growth in agriculture, manufacturing and some services has slowed down. On the external side, exports of soft drink concentrates, caramel colour, sugar, and textile constitute about 70 per cent of total exports and are mainly directed to South Africa. Low Real GDP Growth (per cent) coverage declined to below three months of projected imports. More recently, reserve coverage has fallen further to 2.6 months of imports (May 2017).
Government’s policy of increasing public expenditure, against declining SACU revenue, widened the fiscal deficit and created budget financing shortfalls. The FY16/17 deficit widened to 10½ per cent of GDP (4.6 per cent in FY15/16) as SACU revenue declined and, on the spending side, a salary review increased wage costs and transfers and capital outlays reached the highest level since 2010, largely undoing the adjustment achieved during the 2010 fiscal crisis.
Gross financing needs increased to 21¾ per cent of GDP. The government increasingly tapped domestic markets and, in addition, resorted to central bank financing and accumulated domestic arrears (about 5⅓ per cent of GDP at end March 2017). While still relatively low, public debt jumped to 25⅓ per cent of GDP (from 18.7 per cent), including domestic arrears. Against these developments, market pressures intensified, resulting in declining coverage ratios and rising yields for government securities.
Economic slowdown and government’s financing shortfalls have started adversely affecting the banking sector.
Since 2012, credit growth to the private sector has averaged 11½ per cent, but decelerated to 7½ per cent in 2016 as corporate lending growth turned negative (Figure 5).
However, credit to households for mortgages and durables remained buoyant, contributing to increase household indebtedness. At the same time, banks’ asset quality deteriorated, with NPL rising rapidly and exceeding 10 per cent of total loans (end-March 2017).
As government’s financing needs increased, banks’ direct exposure to the public sector rose and holdings of government securities reached about 11 per cent of banks’ assets.
Against this background, inflation picked up and monetary policy stayed on a tightening course. After averaging five per cent in 2015, headline inflation reached 8.7 per cent in since FY13/14, SACU revenues have been on a declining trend. The sharp decline in FY16/17 compared to the previous year reflected past trends and an adjustment to offset overpayments in previous years.
In 2016, international reserves were boosted by two currency swap operations that in April 2017 amounted to about US 18 million.
The 2016 salary review reformed, among others, civil servant grades, resulting in additional annual wage costs of about two per cent of GDP. Domestic arrears are estimated as the difference between above the line accrual spending and below the line cash financing, accounting for an average end-year float of due payments.
As end-March 2017, authorities’ systems identified pending bills, exceeding 30 days, above four per cent of GDP. Given the volatility of credit series, credit growth refers to 12month average. In July 2016, the Swaziland Central Bank increased liquidity requirements (from 20 to 25 per cent of domestic liabilities to the public), creating an additional incentive for banks to invest in domestic securities.
In 2017, inflation started slowly declining as the effect of the drought faded away. In the context of the peg with the South African Rand, the CBS raised the policy rate in 2016, and again in January 2017 to reach 7.25 per cent, for the first time in years, above the South Africa Reserve Bank (SARB)’s rate, citing elevated risks . Aware of the long-term challenges, authorities have adopted plans to boost growth and foster social and economic transformation, but results have been mixed. In the context of their 2022 vision, authorities have increased public investment, and deployed incentives to boost private investment and economic diversification. However, the impact of these initiatives has been limited, particularly on private investment, employment and economic diversification.
On the positive side, macroeconomic stability has been maintained. However, implementation of recent staff’s advice has been uneven, especially in the fiscal area, and new challenges are rising.