SA must pro­vide a plan for cut­ting debt costs and be­fore it is too late

Business Day - - OPINION - War­ren Brown ●

The govern­ment needs to pro­vide in­vestors, par­tic­u­larly for­eign hold­ers of SA debt, with a cred­i­ble plan as to how the coun­try will re­duce its debt and man­age the ser­vic­ing costs.

Debt-ser­vice cost is the in­ter­est paid on a coun­try’s debt — the greater the debt, the greater the ser­vice costs. Fi­nance min­is­ter Tito Mboweni said in an Oc­to­ber 2019 speech, re­gard­ing SA’s grow­ing debt­ser­vice costs, that the con­se­quences of not act­ing now would be gravely neg­a­tive for the coun­try. “Over time the coun­try would likely face mount­ing debt-ser­vice costs and higher in­ter­est rates and may en­ter a debt trap.”

Th­ese words were spo­ken be­fore the ad­di­tional Covidre­lated R500bn pack­age was an­nounced. SA’s debt as a per­cent­age of GDP was 62% in 2019 and the IMF projects it will grow to 77% in 2020.

Moody’s In­vestors Ser­vice says 2019’s fig­ure is higher — 69% — if one in­cludes guar­an­tees to state-owned en­ter­prises (SOEs).

SA is not alone in the level of ac­cu­mu­lated debt; sev­eral “ad­vanced economies ” sit with (rel­a­tively) more debt to pay off. Com­pared with other al­ter­na­tives of rais­ing pub­lic fi­nan­cial re­sources, pub­lic in­debt­ed­ness is not usu­ally con­sid­ered to ad­versely af­fect the mone­tary sta­bil­ity of a coun­try. This is be­cause it mostly in­volves re­dis­tri­bu­tion of ex­ist­ing re­sources in the econ­omy. Be­sides, gov­ern­ments can ac­cu­mu­late debt and sim­ply roll it over to the next gen­er­a­tion to ad­dress.

One may, ac­cord­ingly, be tempted to say pub­lic debt ac­cu­mu­la­tion is ac­cept­able.

Not so. There are con­se­quences. In early April 2020, Moody’s pushed Ar­gentina’s rat­ing deeper into junk ter­ri­tory due to de­te­ri­o­rat­ing debt is­sues. The IMF put Ar­gentina’s debt as a per­cent­age of GDP for 2019 at 89%. There is no pro­jec­tion for 2020. Debt-ser­vic­ing costs are above 13% of GDP for the next five years, as­sum­ing GDP stays at cur­rent lev­els.

Since the debt struc­ture for each coun­try is rel­a­tively com­plex, cal­cu­lat­ing the in­ter­est due is not a quick ex­er­cise. A rough and ready method is to ap­prox­i­mate the in­ter­est due on the out­stand­ing debt by us­ing the in­ter­est rate on the 10-year bond for each coun­try.

The amount of in­ter­est paid on out­stand­ing debt is more im­por­tant in spark­ing a fi­nan­cial cri­sis than the debt-to-GDP ra­tio. One study sug­gests that if the debt-ser­vic­ing cost ra­tio rises above 5%, this may spark a fi­nan­cial cri­sis if ex­pec­ta­tions are that the level will re­main above that level and con­tinue to rise. SA’s debt-ser­vic­ing cost as a pro­por­tion of GDP is 3.2%, be­low the 5% hur­dle sug­gested above but in line with strug­gling Euro­pean coun­tries such as Spain and Italy.

Another in­di­ca­tor con­firm­ing the grow­ing debt bur­den is the in­crease in the bud­get deficit as a re­sult of in­creased govern­ment bor­row­ing and spend­ing. The pro­jected deficit as a per­cent­age of GDP for 2020 of 13.3% will be the largest yet for SA, with the pre­vi­ous largest of 11.6% in 1914. This pro­jec­tion looks worse than those for other se­lected emerg­ing-mar­ket and mid­dlein­come economies.

The fis­cal deficit is the sum of the pri­mary deficit and the in­ter­est pay­ments. Us­ing data from the IMF, we can re­fine the ear­lier num­bers that in­di­cated debt in­ter­est as a per­cent­age of GDP. If we ex­am­ine debt­ser­vic­ing costs as a per­cent­age of GDP across coun­tries us­ing data from the IMF’s Fis­cal Mon­i­tor April 2020, SA’s pro­jected ser­vic­ing cost for 2021 is the worst among its ad­vanced-econ­omy peers at 5.2%.

Not all debt is bad. Selfliq­ui­dat­ing

or pro­duc­tive debt is debt spent on cre­at­ing as­sets that are ex­pected to gen­er­ate in­come to pay (at least) the prin­ci­ple and in­ter­est due on that debt. Debt ded­i­cated to re­liev­ing the neg­a­tive ef­fect of Covid-19 is, how­ever, not selfliq­ui­dat­ing debt.

There are sev­eral ways a govern­ment can re­duce debt. One way out of pay­ing back the prin­ci­ple and the in­ter­est is to de­fault. The more the debt and the in­ter­est pay­ment bur­den grows, the greater the po­ten­tial for de­fault.

Another way to re­duce debt that could raise se­ri­ous risks is to amor­tise the debt value through higher in­fla­tion. Ris­ing in­fla­tion has sev­eral as­so­ci­ated risks, not least the de­struc­tion of sav­ings and other as­pects of eco­nomic ruin.

A plan is needed to man­age ex­pec­ta­tions, par­tic­u­larly as to how SA will re­duce its debt and en­sure that the in­ter­est pay­ments are man­age­able with­out neg­a­tively af­fect­ing eco­nomic growth. Ris­ing fu­ture debt would re­duce po­ten­tial growth and sti­fle ef­forts to im­ple­ment new pol­icy ini­tia­tives.

High debt lev­els re­duce the flex­i­bil­ity of fis­cal pol­icy to re­spond to eco­nomic shocks such as the fi­nan­cial cri­sis of 2008/2009.

Overindebt­ed gov­ern­ments will find it dif­fi­cult to ex­tend cred­i­ble guar­an­tees to the fi­nan­cial sec­tor.

Sim­i­larly, an overindebt­ed SA govern­ment would find it dif­fi­cult to use moral sua­sion (or other) to con­vince in­vestors that debt is­sued by SOEs (or their prox­ies) would be sup­ported by the govern­ment in cases of de­fault.

There isn’t a con­vinc­ing debt re­duc­tion plan that will ex­cite in­vestors, at least not yet.

For­tu­nately, since it is still early days, fi­nan­cial mar­kets and rat­ings agen­cies will give SA more time to present a plan — but they will reprice the coun­try down­wards in the ab­sence of one.


Brown, a for­mer lec­turer at the UWC School of Busi­ness and Fi­nance, is CIO of MiPlan As­set Man­agers.

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