Much of the conversation about the historic R500-billion economic and social support package recently announced by President Cyril Ramaphosa has focused on where the money will come from.
The decision to apply for funding from the International Monetary Fund has raised concerns from those who recall the IMF’s damaging structural adjustment programmes of the past. But these critics are, as Finance Minister Tito Mboweni said, “making a mountain out of an anthill”.
While the IMF today is not the austerity-enforcing body it once was, our economic policymakers continue to ignore the funding potential of the South African Reserve Bank.
How much does South Africa need?
The treasury has clarified that it is seeking R95-billion in credit from international financial institutions. But the post-lockdown period will probably require more borrowing to recommence projects abandoned because of reprioritisations and to introduce new projects (especially infrastructural) to stimulate growth in the economy. The huge hole in revenue collection anticipated by the South African Revenue Service will further add to this borrowing requirement.
South Africa cannot approach the economic crisis with austerity. The temporary budget reprioritisation to battle the coronavirus is necessary. But even more important is the countercyclical spending needed once the worst of the pandemic is over. Investment in productive, labour-intensive areas of the economy is needed to get South Africa out of its low-growth, high-unemployment path.
So, what are the options?
There are four fundraising possibilities: raise debt through government bond auctions, approach international financial institutions (IFIs) such as the IMF and World Bank, approach individual countries for bilateral loans or sell government debt to the Reserve Bank (quantitative easing, QE). The government must choose the cheapest way to fund this debt.
Raising funds in the normal manner of issuing government securities is not the right approach, with bond yields already in the double digits. Bilateral loan agreements are also unsuitable. The global economic crisis means there is little bilateral funding available, and the conditions attached to these loans are increasingly controversial. Those who see China as a benevolent ally believe it would be a more favourable source of a loan than the “untrustworthy” IMF, despite China’s growing reputation for the unforgiving terms of its loans. China’s demands for collateral often allow it to repossess key components of its debtor’s economy (usually ports or mines).
Thus, the treasury has stated its intention to raise roughly R95-billion through emergency assistance from the IMF, World Bank, and New Development Bank (NDB). The NDB is providing up to R19-billion and the World Bank just R1-billion for specific health and infrastructure projects.
An IMF loan a ‘no brainer’?
The IMF would provide the bulk of funding through South Africa’s entitlement to draw down roughly R80-billion of its Special Drawing Rights (SDR) quota in the form of a Rapid Financing Instrument (RFI).
The RFI is one of the IMF’s two emergency funding options. The interest-free Rapid Credit Facility (RCF) is subsidised by rich members and is available only to the poorest countries – not middle-income countries like South Africa. The RFI is available to every member at a 1.1% interest rate to be repaid over three to five years. Given that five-year government bond yields currently hover above 8%, the RFI comes at a much more concessional rate.
Importantly, the IMF has sufficient rand holdings for the RFI loan to be rand-denominated, which negates the currency risk that some have cited as a reason against an IMF loan.
The terms of a loan from the NDB are less clear, but a loan is likely to be at a similarly concessional rate and also rand denominated. The NDB has already made a $1-billion facility available, and South Africa could draw down another $1-billion later in the year for emergency spending. Given the NDB’s role as effectively an exclusive lender to Brics members (Brazil, Russia, India, China and South Africa), it makes sense to make use of the option at this critical moment.
Much of the concern with a loan from the IMF relates to fears of the strings attached to previous structural adjustment programmes that have strangled developing nations before. But this is a misunderstanding of the nature of the emergency funding that is on the table now.
Unlike an IMF loan to avoid credit default, which attaches strict “conditionalities” to public spending reduction and debt stabilisation as a form of collateral, its emergency funding has no enforceable (“post-facto”) conditionality. It does expect members to commit to sustainable public finances and good governance, but this is not enforceable and is a commitment South Africa has made anyway.
What about the Reserve Bank?
The risks involved in raising debt from IFIs are currently minimal, and concerns from those suspicious of the IMF et al are overblown. But there is a more credible criticism of international loans: the Reserve Bank can perform a similar function in funding the “stimulus”, with no strings attached and fewer risks. Instead of the state taking on a $4.2-billion loan, the Reserve Bank could purchase government bonds to inject the required liquidity directly into the economy.
Since the start of the crisis, the Reserve Bank initiated its first bond-buying programme in an unprecedented move (although this occurred on the secondary market, it still amounts to QE). Pursuing a more aggressive QE approach would both increase the money supply and push down bond yields, making government debt cheaper.
There are two main arguments against the Reserve Bank buying up government debt. The most common concern is inflation. Surely, throwing billions of rand into the economy will cheapen money and push prices up, leading to excessive inflation?
But not at this time: the severe demand shock of the lockdown has almost stopped the normal flow of the economy. Additionally, the depressed oil price is helping to keep inflation at bay. If the inflation outlook does start to worsen, the Reserve Bank can easily respond by tightening its measures.
Reserve Bank governor Lesetja Kganyago is among those making the second main argument against expanding QE. He argues that it has been successful only in rich countries where interest rates are close to zero, because traditional monetary policy would be ineffectual and deflation, not inflation, is the primary monetary risk. In South Africa, he argues, there is plenty of room to cut interest rates if more liquidity is required.
But this point of view is inconsistent with reality. Normally, cutting interest rates — as the Reserve Bank has done twice already and is likely to do again this week — would raise the price of bonds and reduce yields. This has not had the usual effect, as risk-averse investors have deserted emerging markets at unprecedented rates, destroying demand for bonds.
Reducing interest rates will have little effect on bond yields as long as the global economic crisis is ongoing. When it is over, all the new money pumped into the global economy should (hopefully) find its way back to high-yielding emerging market bonds.
South Africa is already borrowing at more than 10% on 10-year bonds, making the argument for QE even stronger. The Reserve Bank should step in to replace the demand lost in the bond market, in a form of “counter-cyclical monetary policy”.
Funding government debt from the market would be prohibitively expensive – creating money is the cheapest way to fund the recovery package.
There is a limit, however, to how much government debt the Reserve Bank can take on to its balance sheet, which has been largely ignored by advocates of aggressive money printing. The Reserve Bank Act (section 13f) precludes it from holding government debt acquired in the primary market that exceeds its capital reserves (about R18-billion) plus one-third of its public liabilities (about R330-billion), limiting its total possible primary bond holdings to about R350-billion. The Reserve Bank should exploit at least some of its capacity in this regard.
But Kganyago has made it clear that he has no intention of bond purchases on the primary market, and the government cannot compel him to. In the absence of further money creation by the Reserve Bank, taking loans from IFIs is a close second.
Why SA will need to borrow
The current global health and economic crisis has made funding for non-balance of payments matters (that is, debt repayment) available at unusually concessional rates. Despite the treasury’s preference for longer-maturity bonds, the borrowing of money from IFIs at this time will give South Africa a more favourable debt profile than financing spending through domestic bond issuance where yields remain sky-high.
As long as the Reserve Bank lacks the will and creative thinking to fund government debt itself, loans are the most feasible and favourable way forward. The abnormally concessional rates and minimal conditionalities of IMF emergency funding means it is too good an offer to refuse. In this context, it is indeed a no-brainer.
Laurent Balt is a political analyst. His research focuses on development and South African politics. Jack Calland is an analyst at a financial sector consulting firm in Johannesburg