Business Day

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

- 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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