Tough calls ahead on borrowing
SA has options, but they come at a cost — economic or political
● Growth is crashing, SA’s fiscal deficit will balloon and financial markets have turned very unfriendly. Where will SA find the money it needs to fund a much higher government borrowing requirement?
There are various options — domestic and external — but they come at a cost, economically or politically.
And while markets are hoping to see a revised “emergency” budget sooner rather than later, the Treasury will want to get better numbers first on how much economic and fiscal damage the Covid-19 crisis is likely to cause — and what the funding options are.
Economists have been revising growth and fiscal forecasts almost daily as they try to estimate the impact on SA’s economy, in a context in which the two-week extension to the lockdown may not be the last, and will multiply the economic impact of the crisis.
In its Monetary Policy Review released this week, the Reserve Bank estimates the economy could contract by 2%-4% this year, and will grow by less than 1% next year — but emphasises the “downside risk” if the lockdown is prolonged or the global environment is worse than expected. The Bank estimates 360,000 jobs could be lost this year, and 1,600 firms could disappear.
PwC’s economists have estimated that in a worst-case scenario the unemployment rate could rise to 47%.
Now, economists expect minus 7%-8% or more, with a budget deficit of as much as 12%. It’s a question not only of how hard the crisis hits demand but also of whether it cuts the economy’s capacity to supply, making any recovery harder and longer.
Lockdown and deep recession mean tax revenues will fall far short of budget targets over the next three years, and that would drive up the budget deficit — and therefore the amount the government has to borrow to fund this — even without any extra government spending to address the health and economic crises.
The Bank says a deficit of more than 10% of GDP is “plausible”. So the question now is how the government funds a much higher borrowing requirement — at a time of unprecedented global and local financial market turmoil which has sent SA’s borrowing costs spiralling. With bond yields spiking, the cost of funding for the government is now about 250 basis points higher than it was at the time of the February budget.
Much of that is related to a global environment in which investors fled to the safety of cash and the dollar as the Covid-19 crisis intensified. That saw a sudden sharp stop in capital flows to emerging markets, with the Institute for International Finance estimating $62bn (about R1.1trn at current rates) flowed out in the first quarter, double the peak seen in the global financial crisis.
In SA’s case, the selloff by foreign investors has seen an outflow of about R100bn since the start of the crisis, of which R70bn was from the bond market.
Moody’s decision to junk SA’s rating could add to that from May 1, when SA bonds are removed from the World Government Bond Index and funds tracking that index have to sell their holdings. But however poor the timing, the Moody’s move just reflected the growth and fiscal challenges SA faces — and any impact now might be quite minor compared to what’s already happened to government borrowing costs on the market.
On the domestic market, the government would now be borrowing at 10% or more, which in real terms is one of the highest rates in emerging markets; borrowing on foreign
Lockdown and low growth mean tax revenues will fall far short of budget targets over the next three years
markets in hard currency has become prohibitive at about 7.5%.
Nor is it just a question of cost but of access to markets and whether, with foreigners fleeing, SA can access enough of an investor base to absorb much higher issuance of bonds. This is where other non-market options have to come in, domestically and internationally.
Finance minister Tito Mboweni has said SA will look at multilateral funders including the International Monetary Fund (IMF) — a proposal that has already roused political controversy. SA is in talks on a $1bn loan, at an attractive rate, from the Brics New Development Bank to address the health emergency. But it is likely to need much more.
SA’s problem is a fiscal one, not the kind of balance of payments problem the IMF usually assists with. However, RMB Morgan Stanley economists Andrea Masia and
Jaiparan Khurana note there are precedents for the IMF lending to countries — such as Russia and Brazil in the 1990s and Morocco more recently — where fiscal issues ultimately led to balance of payments pressure.
There has been talk of more modest short-term funding via the IMF’s Rapid Financing Instrument, but SA could also access as much as $18bn over three years by way of an IMF Stand-By Arrangement. That would of course come with conditions — which would be politically fraught.
The RMB Morgan Stanley economists say markets would cheer an IMF programme for SA, which would provide a “policy anchor” that would help to reduce the risk attached to SA and bring down borrowing costs.
Meanwhile, there are some domestic options. The government has R67bn in sterilisation funds at the Reserve Bank that it could potentially use as bridging finance in a crisis.
This is excess cash the Treasury put on deposit at the Reserve Bank to counter the effects on money supply when they were building up foreign exchange reserves.
It’s also likely that pension funds and other institutional investors who are allowed to invest up to 30% of their assets abroad might have to bring some of that money back to get portfolios back into balance because of the rand’s crash — Masia estimates that could see as much as R120bn of institutional money flow back into SA in coming months.
Inevitably though, the idea of forcing pension funds and other asset managers to invest in government bonds via imposing prescribed assets is bound to come up again.
At a time when those funds are themselves under intense pressure in a declining economy and intensely volatile markets, prescribed assets are likely to be more controversial than ever.