The International Monetary Fund (IMF) has approved a 70 billion rand ($ 4.3 billion) loan to South Africa to help the country deal with the immediate consequences of the COVID-19 fallout. Conversation Africa editor-in-chief Caroline Southey asked Danny Bradlow to shed some light on what South Africans should expect.
What conditions has the IMF attached to the disbursement?
The IMF provided the financing through its Quick financing instrument. This is designed to support countries facing an urgent need for funding due to a crisis such as the COVID-19 pandemic. The aim is to help the country cope with the immediate financial consequences of the crisis. As a result, the IMF provides financing quickly and without strict conditions. The country simply needs to show the IMF that it is facing a crisis, that it will use the funds to deal with the crisis, that it will cooperate with the IMF to resolve the balance of payments problems caused by the crisis and describe the policies it proposes to follow.
In some cases, the IMF may require the country to take certain policy actions before it can access the funds.
In the case of South Africa, the country’s payment problem is related to the fact that the economy is expected to contract by around 7% this year and the budget deficit is expected to increase to around 15% of GDP. This means that the government will have to increase the amount it has to borrow. Since it was downgraded through credit rating agencies, and the economy is in bad shape, there is a significant risk that local and foreign investors may have a limited appetite for South African debt. This will complicate the government’s efforts to finance the deficit.
The IMF loan solves this problem.
South Africa provided the requested information to the IMF in the form of a letter of intent signed by the Minister of Finance and the Governor of the Reserve Bank. The letter has not yet been made public. But, according to the IMF press release, South Africa appears to have informed the IMF of its intention to take certain measures to stabilize the country’s finances. This means that the government will cut public spending to reduce its need to borrow. The ongoing disputes over public sector wages and the financing of state-owned enterprises are examples of measures it could take. The government also said it would improve the governance of state-owned enterprises and introduce reforms to stimulate a growing and inclusive economy. These reforms could include measures to improve competition in different sectors of the economy.
South Africans should accept that the IMF is neither their worst enemy nor their savior
South Africa made these commitments last October medium-term budget statement and in the supplementary budget statement in June of this year.
This suggests that the IMF simply expects the country to implement policies already announced by the government.
How will the money be paid out?
This type of financing is provided in one installment. The IMF press release does not say when the funds will be disbursed but the objective is to make the funds available “quickly”. It could be as early as August.
Once the funds have been disbursed, the government will be free to spend them. According to the national treasure declaration, he plans to use the money to support health and frontline services, protect vulnerable people, stimulate job creation, support economic reforms and stabilize public debt.
All of this is in line with the goal of the quick financing instrument and the government’s stated intentions.
But these goals are very general and we will need to see in more detail what exactly the government will spend the funds on.
What restrictions are there on the government’s ability to use the money?
The IMF loan does not impose conditions beyond what is in South African law on how the funds can be used. Therefore, the funds will be subject to the same procurement and accounting requirements as all other budgetary expenditures.
In addition, the government will have to account in its future budget statements and reports to parliament on how the funds have been used. South Africans will also be able to demand that the government demonstrate that the funds have been spent in accordance with the requirements of the constitution and the Bill of Rights. This means that the government must show that it is using the maximum available resources, whatever the source, to help realize all the rights that South Africa’s constitution and international commitments grant to South Africans. .
The IMF requires South Africa to repay funds to the IMF over 20 months starting 40 months after the loan is disbursed. This means that South Africans will have to make sure that the funds to repay the IMF are properly budgeted.
What are the advantages of the loan?
The biggest advantage is that South Africa gets $ 4.2 billion at around 1.1% interest. It is a very cheap source of funds. If the government tried to raise the same amount in domestic markets or other international sources, it would pay a considerably higher interest rate – the current rate for government bonds of comparable maturity is around 7%.
The second potential benefit is that the IMF loan will catalyze other funds for the country. In other words, investors in South Africa and abroad will interpret the IMF’s action as an expression of support for South Africa and this will give them the confidence to invest in South African debt. Since foreign investors hold approximately 30% of South African government debt denominated in rand this boost in confidence could be significant. This will both reduce the incentive for these investors to sell their government bonds, which could drive up interest rates, and allow the government to issue new debt if necessary.
The third benefit is that by helping stabilize the situation in South Africa, it will limit the damage that could be inflicted on neighboring countries. This, in turn, could help South African exports and thus help preserve jobs and income in South Africa.
What are the disadvantages ?
The most important disadvantage is that the loan is denominated in foreign currency. So South Africa has to bear the risk that if the rand depreciates, the loan and the interest on it become more expensive. Given the state of the South African economy, this risk is not negligible.
But it is important to keep in mind that the IMF qualifies the loan and the repayment obligations as Special Drawing Rights. It is the special form of IMF currency and its value is made up of a composite of a basket of currencies. These include the US Dollar, Euro, Japanese Yen, Chinese Renminbi, and British Pound. The values of these currencies tend to fluctuate against each other, so some appreciate while others depreciate. This helps mitigate the currency risk that South Africa has to bear.
The second risk is that if South Africa does not use IMF funds wisely, the country’s economic situation deteriorates and it struggles to repay debt.
If that happens or if the pandemic lasts longer than expected, the country could be forced to seek additional support. In either case, South Africa’s negotiating position would be significantly weaker.