Apr 7, 2021
Interestingly, the UK (85%), the US (91%) and Japan (250%) are not viewed with the same concern. The reason is the sustainability of the debt, both in absolute and relative terms.
However, assessing the sustainability of debt in any given country is a complex question. The Institute for International Finance and Deutsche Bank recently compiled a list of the change in debt-to-GDP ratios between the fourth quarter of 2019 and the third quarter of 2020 across 32 countries across their household, corporate and government sectors. South Africa ranked 11th from the bottom, with an increase of 17% of GDP, the bulk of which was in the government sector. In contrast the UK has seen a 33% increase in that period, again concentrated in the government. The US has seen a 43% increase spread between borrowing by the government and corporates. Japan has seen a 50% increase. In South Africa, the surging share of revenues (or borrowing) diverted to making interest payments is due to two main factors; the growing debt burden and persistently high interest rates (which in turn compound the debt burden).
The reason the UK, the US and Japan can afford massive increases in debt burdens is because their borrowing costs have plunged. If the US government borrows for 10 years at just under 1%, they can afford to support the massive amount of the money they have borrowed this year. If Japan or the UK government borrows 10-year money at slight negative interest rates, they have no problem with debt serviceability. In contrast, South Africa has no such leeway. South Africa’s interest costs are high, and the 10-year yields have shown little downward movement through this crisis:
The only way out of this debt trap is to address the root of SA’s problems: weak growth. During a recent panel discussion, senior members of the fixed income team at Ninety One shared that our situation is by no means unique in the world. While further deterioration in debt profiles will ultimately become unsustainable, South Africa is not alone, with debt burdens across the developed and emerging worlds ballooning.
What, then, of the future? Ninety One believes that fiscal consolidation and structural reform can move us towards sustainability, and that investors have a role to play, by constructively engaging on pressing issues in order to make an impact.
Essentially, there are two perspectives. One is the amount of debt (measured relative to GDP) and the other is the affordability of that debt (measured by how much revenue – that is, tax - must be allocated to paying back that debt).
Figure 1: Rising debt = government bond indigestion
Source: Ninety One, data as 24 February 2021
The left-hand chart above tracks the level of debt incurred and how it evolves over time under different scenarios, and the amount of borrowing that translates into, in Rands per year, on average over the next 8 years. Under the MTBPS scenario in October 2020, it amounts to around triple the borrowing incurred in 2017/2018 – peaking at 95% of GDP in 2025/26. While debt/GDP is a widely used measure, it is also important in understanding sustainability whether the market can accommodate the amount the sovereign wishes to borrow. Measured by how much yields move on Tuesdays, when government comes to market, we’re on the cusp of the amount the market believes to be unsustainable. While it’s mentioned often, inflation is not the solution – nominal growth (and hence tax) might rise, but the cost of borrowing would also rise, pushing the absolute amount required per annum well north of R800bn as evidenced in the graph.
On the right-hand side above we graph the affordability of that debt, and its evolution. We expect interest to consume 22% of tax revenues every year, under the current scenario. This is a very large number, taking money away from important policy objectives such as social spending, healthcare, education or even growth-positive spending in infrastructure. This in turn creates social and political problems. However, the graphs both make it clear that there has been an improvement between the MTBPS last year and the Budget this year – to what can this be attributed? It’s down to a R100 billion overshoot in tax revenues versus low post pandemic expectations. However, it’s key that issuance now continues to be cut and spending be properly managed by the Treasury, and the overrun not be squandered.
We considered the example of Jamaica, which has similarities to us in having low levels of dollar denominated debt – but which hit 60% of tax revenues in spending on interest. Jamaica defaulted in the face of this number, unable to run the country. Other warning examples abound, such as those below.
Figure 2: Fiscal balance % GDP
Source: IMF and Ninety One
What can we then do to ensure we do not fall into the Jamaican trap? There are many options.
Figure 3: Dealing with the debt burden
Source: Ninety One
Of all these options, the two that offer the most scope are reducing spending and encouraging growth, with growth the most sustainable. We’ve seen appetite from treasury to reduce and change expenditure already, towards growth-positive expenditure items. The balance of options is much less attractive, if not downright dangerous. There’s not much room in South Africa to raise taxes (and in fact Treasury has provided some tax relief), while inflation will backfire as described. Defaulting is clearly not a road we want to travel - and is one we can avoid. Financial repression (forcing the market to buy your bonds) is a spectrum depending on how onerous it is and we already have some forms of investment restriction (exchange controls being an example) here, with extensive repression abroad in the form of low rates – but we do not have the scope developed economies do to exert the necessary pressure. Funny money involves versions of expanding the balance sheet of the Reserve Bank – but the market is signaling that we have a fiscal problem, which can’t be fixed by funny money.
Fortunately, confidence levels are so depressed that investor expectations of future growth prospects can be dramatically boosted by a few key actions. What can be done to boost South Africa’s growth prospects, reduce our borrowing costs and make our debt sustainable?
Finally, engagement with stakeholders, including Treasury and SARB, is vital.
Figure 4: Our approach to proactive engagement
Source: Ninety One