South Africa is on a cliff edge – just as it was in 1985
Current developments in South Africa are reminiscent of events in 1985. In that year South Africa experienced high costs from currency depreciation and adverse political developments. At the time the country faced increasing international sanctions and isolation, while the exchange rate of the rand remained under severe pressure, recording sharp falls in the international value of the rand.
South Africa’s financial stability was put under severe pressure after the infamous Rubicon speech of then State President P W Botha. Before the speech, high expectations were raised internationally about the announcement of major political changes in South Africa, but these expectations did not materialise. Following the speech, foreign banks refused to roll over South African short-term foreign debt, causing further depreciation of the exchange rate of the rand.
In 2016 South Africa might see a slow motion repeat of the events of 1985, culminating in a debt standstill. The following events, reminiscent of developments then, could unfold:
- a continued depreciation of the rand, accelerated by the President’s inexplicable decision to remove his Finance Minister. The depreciation substantially increases the capital value of and interest repayments on foreign debt; and
- a downgrading of South Africa’s credit rating to junk status that results in credit lines being withdrawn by foreign funders such as banks.
This time we can see trouble ahead and the government should act responsibly to avert a slow motion replay of 1985.
Currency depreciation brings certain benefits to a country. The most obvious is the fact that exports become cheaper abroad and that demand for exports are therefore stimulated.
Unfortunately currency depreciation does not only bring benefits. Imported goods and services also become more expensive. More expensive imports put pressure on domestic inflation that can result in increases in interest rates. In economics it has often been said:
There is no free lunch, everything has a cost, even if then only an opportunity cost.
Currency depreciation also increases the capital value of foreign debt in domestic currency (where foreign debt are designated in foreign curreny) and the interest burden on such debt, as interest is also paid in foreign currency.
In short: in 1985 an unwillingness of banks abroad to make loans to South African entities (albeit for political reasons) plus the depreciation of the currency resulted in the inability of the country to repay its foreign debt.
The financial crisis culminated in the “Debt Standstill”, a moratorium on the repayment of most of South Africa’s private sector foreign debt, but excluded government debt. Debt repayments were managed by a Debt Standstill Committee and rescheduled over an extended time period, with the last of the rescheduled debt repaid in 2001.
The falling rand
In recent months the exchange rate of the rand has shown considerable depreciation. This is actually an acceleration of a long-term declining trend. The nominal effective exchange rate of the rand has lost around 50% of its value since 2010.
The South African Reserve Bank describes the nominal effective exchange rate as
… a weighted exchange rate of the rand measured against a basket of the currencies of South Africa’s twenty most important trading partners. The calculation is based on trade in and consumption of manufactured goods.
On this basis, measured against 20 currencies, the rand has therefore lost about half of its value.
In assessing the “Debt Standstill” with the benefit of hindsight, it is important to distinguish between South Africa’s foreign debt and South African government debt, as only private sector foreign debt was caught in the standstill.
The country’s foreign debt is all funds borrowed abroad by South Africans, including companies, other entities and private individuals and includes the government’s foreign borrowing. By the middle of 2015 South Africa’s foreign debt amounted to some R1.7 trillion, of which 46% was denominated in foreign currency.
South African government debt is the total of all funds borrowed by the government to balance its budget. South African government debt at present amounts to some R1.8 trillion. Of this, some R190 billion (10%) is foreign debt, while the balance is borrowed from pension funds, banks and the like in South Africa.
South Africa’s foreign debt naturally includes the portion of the South African government debt borrowed abroad, comprising about 11% of the country’s foreign debt. The balance is supplier credit, trade credit and the like. For instance: if a foreign supplier sells to a South African company and provides a six month credit line, the credit line is part of the country’s foreign debt for a period of six month.
This credit line has nothing to do with the South African government’s debt position, domestic or foreign. Government debt and the country’s foreign debt should not be confused.
Since 2007 South African foreign debt has shown a steady increase as percentage of both the gross domestic product (GDP) and total export earnings (TEE). At the same time interest payments on foreign debt as percentage of TEE have increased.
South Africa’s foreign debt position (which should not be confused with the debt of the South African government) is vulnerable in three respects. First, currency depreciation raises the capital value of the funds borrowed abroad in foreign currency, hence increasing the repayment burden on South African borrowers. Foreign debt as percentage of GDP increases owing to currency depreciation.
Secondly, interest payments on foreign debt increase owing to currency depreciation. This will be exacerbated by an international normalisation of interest rates. The result might be a raising TEE if the combined result of higher international rates and currency depreciation exceeds the increase in exports owing to currency depreciation.
These two factors were present in 1985, but were exacerbated at that time by political considerations, namely banks refusing to lend more money to South Africa after the Rubicon speech. The last element for a repeat of 1985 in slow motion might be triggered by another event some 30 years later: a credit risk downgrading to junk status of South Africa by international rating agencies.
Now that South Africa’s international risk rating is downgraded to junk status, international banks and other companies will be much more reluctant to make loans to South African entities, or will even withdraw existing credit lines.
This might be the seismic event similar to the withdrawal of international credit lines for political reasons in 1985, culminating in a debt standstill. The South African government should introduce in a timely fashion policies to avert a repetition on the events of 1985.