South Africa: A Currency Blowout May be Next

The South African Economy could be more than predictably hurt with the huge debt pile.

South Africa’s public debt stands at 50.1% of the country’s Gross Domestic Product (GDP). This is double the 2006 figure. Of the country’s $173 billion (R 2.4 trillion) debt, 90% is held in local currency. This could mean a fall out of global bond indices leading to reluctance by investors to purchase its debt. A non-action to government borrowing may lead to inability to service debts. A government deep in debt is very predictably, perceived as risky, and hence a high cost of borrowing would ensue, as lenders demand premiums. South Africa is also currently pressured by low revenue collections with the slowing economy.

The recent credit downgrade may trigger a capital flight. Credit downgrades make fixed income securities and bonds unattractive to foreign bond investors, and they would move to more attractive markets. For a country with USD 4.5 billion (R 62 billion) in government securities held by foreign investors, this can be devastating, as the Rand will be weakened.

Equity holders may not be affected the same way as the bondholders. This is because 39 of the 472 listed companies have dual listings. The companies with listings elsewhere will not be as vulnerable as the ones with single listings. This is because the companies earn in foreign currency from abroad. The singly listed businesses will be adversely affected by the declining performance of the economy and a weakening currency. With most of them listed only in South Africa, the impact can be so immense. In a bid to protect themselves from future loses, they will be driven to internationalise, ahead of further weakening of the economy. In this process, companies’ valuations will be much lower because of the escalated capital costs.

The Rand’s R 14/USD average at the end of 2016 has further declined beyond its low point of about R 20/USD level in the medium term. Political subversion and the reshuffle of the cabinet, with removal of the Finance Minister, have had a great contribution to the financial crisis. Domestic and foreign investments have suffered, raising long-term interest rates as well. So, increased borrowing costs and higher interest rates will negatively affect the government’s financial standing.

South Africans are the biggest borrowers, with approximately 20% of consumers being three months in arrears. With higher interest costs, the repayment would be more burdensome. The government, burdened to pay the debts, will raise the taxes. Politically, this will be unpalatable since it will further burden the low-income populations in the rural areas and the overtaxed middle class. This can really disorganize the ruling party, ANC.

Since South Africa has had budget deficits for the past 20 years, the rating downgrade will require that the government either injects more money in the economy, or, borrows more. Releasing money into the economy will ignite inflation and affect exchange rates. This will lead to heightened interest rates from the central bank, further hurting consumers. If the government goes the borrowing way, it will be sinking itself deeper in debt to levels where it cannot service. But much as borrowing can be an option, the ability to raise more money will be limited since the credit rating is very poor currently.

 

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