Middle East and Africa | Trotting towards a bail-out

South Africa gets a rating downgrade

Mismanagement and magical thinking are driving the rainbow nation into a debt crisis

“OUR sovereignty in South Africa was incredibly hard won, steeped in blood and pain,” said Trevor Manuel, the country’s former finance minister, recalling the debt crisis he had inherited at the end of apartheid in 1994. Faced with a contracting economy, rising public debt and spiralling debt-service costs, the new democracy seemed to be heading towards an IMF bail-out that would have entailed it handing over control of its economy to international creditors. Instead, as Mr Manuel recounted in an interview with the Daily Maverick, a news website, in 2014 on the eve of his retirement from politics, South Africa cut state spending to ensure “we weren’t going to become a client state of anybody.”

Two decades later the country is again moving towards the edge of an economic precipice. Public debt is rising fast, as are the costs of servicing it. The economy has staggered to a near-standstill. On December 4th Fitch, a rating agency, cut its assessment of South Africa’s creditworthiness, saying its debt was now just one notch above “junk”, financial jargon for bonds below a certain rating that have a higher risk of not being repaid. On the same day Standard & Poor’s, another agency, changed its outlook for the country, implying it was likely to downgrade its rating to junk over the next two years.

The agencies’ statements spooked bond and currency markets. South Africa’s long-term bonds slumped and the rand weakened to a record low against the dollar, on concerns that the country’s government bonds may lose their investment-grade rating. If that were to happen large numbers of foreign investors would be forced immediately to sell their holdings because many have rules prohibiting them from owning “junk” bonds. That in turn would drive up South Africa’s borrowing costs and potentially force it again to consider an IMF bail-out.

This slide towards a bail-out is by no means inexorable, not least because, as Mr Manuel recalled, a government led by the African National Congress (ANC) has pulled the country back from the brink before. In 1994 government borrowing amounted to about 50% of GDP (see chart). More worryingly, interest payments on this debt then accounted for more than 5% of GDP, in part because it was forced to offer juicy yields on its bonds in order to attract investors. With an economy that had contracted for three of the previous five years, South Africa was facing the prospect of a runaway debt spiral in which it was having to borrow more simply to keep up payments on its existing debt.

Back then the ANC’s response was as decisive as it was unexpected for a party that professed to be socialist and had come to power promising a radical economic policy based on increased state spending on housing, education and basic social services. The ANC-led government passed a series of tough budgets that trimmed state spending as a share of the total economy. Over a decade it turned a persistent fiscal deficit into a surplus. By 2008 it had slashed public debt to 26% of GDP and more than halved interest payments as a share of GDP.

Under Jacob Zuma, who was elected president in 2009, debt has steadily crept back up to the 45% mark. That may seem comfortably low compared with many European countries such as Britain, whose public debt is more than 80% of GDP, but South African interest rates are four times higher than Britain’s (8.6%, compared with 1.9%). To be fair, some of the increase in debt arose from a sensible policy to use government spending to offset a slump in the world economy during the financial crisis of 2008. But having opened the spigots, the government has proved unwilling to close them: pay increases for civil servants, for instance, are running far ahead of inflation. The government is running a deficit of nearly 4%. Greater fiscal rectitude might be politically painful, but there is little reason to fret that measured efforts to slow government spending on salaries would harm the economy much, especially if some of the savings were channelled into investments in infrastructure.

A second reason to hope that this slide towards a bail-out is not unstoppable is that faster economic growth could help to arrest it. Both Fitch and Standard & Poor’s cited slow growth among their chief concerns. This year the economy will be lucky to squeeze out much more than 1% growth and next year’s outlook is scarcely much better. Weak commodity prices and a sluggish world economy are all contributors to slow growth; an imminent rise in American interest rates has sucked capital out of all emerging markets, including South Africa. Even so, many of the barriers to faster economic growth are within the government’s gift to change.

Among these are power shortages that have closed factories and mines because of underinvestment by the state-owned electricity firm, Eskom. Liberalisation of electricity generation alone could probably lift the country’s economic growth by about 1% a year. A similar annual boost to economic growth could come from encouraging private investment in overcrowded ports and congested railway lines that have been holding back exports.

Yet liberalisation of the economy has taken a back seat under Mr Zuma to his government’s desire to have a strong “developmental state”. This is the notion that the government should own important bits of the economy and use them to drive economic growth. It continues to pump money into economic albatrosses such as South African Airways, which has soaked up more than 30 billion rand ($2.3 billion) in bail-outs over the past two decades, and maintains monopolies such as Eskom’s, no matter how poorly they perform.

South Africa probably has another 18 months or so before ratings agencies decide whether to cut its debt to junk. That is ample time to change course, but there are scant signs of a new direction. “In the cabinet there are those who understand why a credit rating is important and those who have no clue about what it means,” says an executive at one large South African company. “Those who get it are a shrinking minority.” The lessons of 1994 appear not to have sunk in.

Discover more

After pushing its economy to the brink, Egypt gets a bail-out

But a record-setting investment from the UAE will not fix its chronic problems

Gaza is on the brink of a man-made famine

Israel and Hamas reject a ceasefire even as people starve


Senegal proves the doomsayers wrong

Bassirou Diomaye Faye’s win is a triumph for the country’s democracy