Will Eskom drive us into IMF’s arms?
If scandal-hit Eskom is not in as good financial health as it would like us to believe, South Africa could find itself closer to seeking an International Monetary Fund (IMF) bailout than ever imagined.
Eskom’s financial results, released this week, paint a rosier picture of its financial standing than anticipated. But a closer look at the financial statements shows a growing debt overhang, presenting costs the utility may well be unable to afford when they come due, because of chronically declining sales and plummeting profitability. Finding funding for the utility has also become more difficult as investors grow increasingly reluctant to buy its bonds.
The treasury has told the Mail & Guardian that the government will implement all the necessary measures to ensure that Eskom remains financially viable and ultimately operates on the strength of its own balance sheet.
Asked what it would do if Eskom were to require an urgent bailout, the treasury referred to Finance Minister Malusi Gigaba’s 14-point plan that seeks to provide Eskom with “soft support” until a tariff adjustment next year.
It said it was up to Eskom to propose what such support should be.
The treasury insisted it would also not borrow money from the IMF in the “near future”, but a financially unstable Eskom could quickly drive the country into its arms.
State-owned entities and the risk they pose to the fiscus have been of concern to investors generally, but the worst-case scenario is that a too-big-to-fail entity like Eskom suddenly and urgently requires a capital injection.
In this case, Gigaba will inevitably find that, for easy funding options, the cupboard is bare.
SAA recently received yet another bailout from the government, this time for R2.3‑billion, but it’s small fry compared with the type of cash injection a distressed Eskom would require. In the past, the government has extended a subordinated loan of R60‑billion to Eskom that is drawn down in tranches over three years. In 2015, a government stake in Vodacom was sold to inject R23‑billion in cash into the entity.
There would appear to be no easy way to raise such money in the current economic climate, especially when it is to fund a scandal-hit parastatal.
If Eskom needed to be propped up, or a similarly large demand was placed on the budget, it’s clear that revenue collection wouldn’t cover the gap. If anything, tax collection is likely to fall short — a situation induced by an official recession and poor consumer confidence, and certainly not helped by an apparent weakening of the South African Revenue Service.
“Most things that give you a revenue injection will deteriorate the economy further immediately,” said Gina Schoeman, Citibank’s chief economist for South Africa.
Stanlib’s Kevin Lings agreed: “If faced with such a shortfall, there is little the state could do that would not make the situation for the economy much worse.”
The first option considered might be for the government to extend further guarantees to Eskom — although government guarantees are widely seen to be maxed out.
“Your finances would look okay. It would go into your contingent liability numbers [not debt numbers], which are second-tier numbers,” Lings said, noting that, although the ratings agencies were watching these, it would have the least effect on South Africa’s financial position.
However, in such a scenario Eskom could go to market with these guarantees but the market may not fund it or may only do so at a high interest rate.
Already, the utility issues debt at a fairly high cost compared to the sovereign. “Without government support, this thing would be a complete dog,” said Dirk de Vos, chief executive of advisory firm QED Solutions.
The other option would be to issue debt as the government, which is generally easier but would immediately push up debt levels and have a number of ramifications such as further ratings downgrades — which, in turn, would increase the cost of borrowing and the state’s vital debt servicing cost.
Breaching the debt ceiling to bail out a flailing utility would be a trade-off, Schoeman said, adding: “It would put South Africa in a worse standing.”
Increasing debt levels and worried investors would spell big trouble for South Africa, which has already faced a series of credit rating downgrades. As a result, its dollar-denominated debt has been junk rated but its local currency debt is not yet sub-investment grade. As noted by De Vos, maintaining this rating is especially significant because the bulk of the country’s debt is issued locally.
Gigaba’s 14-point plan already includes the sale of noncore assets as part of a general strategy to fund inclusive growth.
Asked what noncore assets the country has available for sale, the treasury told the M&G that, in line with the 14-point plan, the government is in the process of disposing of noncore assets, but could not elaborate on what these are or what revenues they might bring in.
“The details will be published in the 2017 medium-term budget policy statement to avoid price manipulation from the market,” said treasury spokesperson Zwikhodo Singo.
The R23‑billion Vodacom stake that was sold to fund Eskom in 2015 was seemingly low-hanging fruit, with no further easy pickings coming to mind — although the government is still building up its asset register, Lings said.
The 14-point plan also includes privatising some state-owned entities. But now that the ones that require funding are in bad shape, one has to wonder who would want them.
If, in a crunch, the privatisation of a state-owned entity were to be accelerated, it could be complicated by the fact that many of these entities have solvency ratios that are not attractive to buyers, Schoeman noted.
Lings said: “You would have to recapitalise many of these institutions. Generally, the private sector wants to know it is buying an entity that is well capitalised.”
He noted that this was even more important if the privatisation were partial and the state were to retain a controlling interest. “If the state were to relinquish the asset, it might find buyers at a certain price.”
But it was not likely to serve as a quick funding fix. “The problem is it’s time-consuming to raise money through a privatisation programme. The timing might not work.”
Prescribed assets would be a fairly easy option to implement. “You simply make it a law that all pension funds have to invest [in state-owned enterprises such as Eskom],” said Lings.
De Vos also believed the state would go this route before it looked at an IMF facility. However, Lings said, if prescribed assets scared off a significant portion of foreign investors in the bond market, it could drive up the cost of borrowing for Eskom and others.
There are some rats and mice to consider. A total of R6‑billion was budgeted for government contingency reserves for the current financial year. And Lings pointed out that, as a paid-up member of the IMF, South Africa can draw down on the R3‑billion it has paid in fees to
the fund over time with no conditions imposed on such a loan. The last time the country drew down was in 1982.
The government could also approach the Brics Development Bank (servicing the Brazil, Russia, India, China and South Africa bloc), the China Development Fund or even sovereign wealth funds. But Lings doubted they would have the kind of capital required.
Once a country accepts an IMF bailout as its fate, it will need to approach the fund itself.
Generally, the IMF steps in to fund a country whose finances have deteriorated to the point that it faces a balance of payments crisis — when a country can no longer access foreign finance, when the current account deficit and currency are under pressure and a capital injection is needed to stabilise the situation.
Lings said it would be possible to approach the IMF prior to that point, if a government wanted to.
An IMF loan facility comes at favourable rates but is accompanied by conditions, usually in the form of reforms. Not many countries like the idea of their monetary policy being dictated by the IMF, although the fund’s conditions have become less restrictive.
At the ANC policy conference early this month, the M&G asked the party’s economic transformation committee head, Enoch Godongwana, how far South Africa might be from seeking an IMF bailout.
He referred to the events of 1985 following PW Botha’s infamous Rubicon speech in which Botha failed to announce much-needed reforms, prompting a commercial and financial run.
“South Africa was going to default on debt and therefore went for debt rescheduling,” he said. “So I’m saying that people do not understand then that if we continue going into a recession, if revenues continue to decline, our fiscal space is more limited to finance anything, forcing our debt levels to go up.”
Debt levels on their own are not an issue, but the capacity of the government to service that debt is a critical issue, Godongwana said. South Africa’s debt service costs are the country’s fastest-growing budget item.
He indicated that contingent liabilities, in the form of guarantees to the parastatals, posed a risk as their balance sheets grow weaker and guarantees may be called in, negatively affecting the government’s cash position.
Lings agrees with the treasury that South Africa is some way away from requiring an IMF facility.
“We could extend the domestic bond issuance and push that a bit, and could push taxes further. A VAT hike remains an option. Or we could get more aggressive on cutting back on frivolous spending,” he said.
“At some point the writing is on the wall: make reforms work or slippage will just continue.”