The prospect of an International Monetary Fund (IMF) bailout has become a controversial discussion point in the last few months; and with South Africa’s recent credit rating downgrade, coupled with the economic pressures that we are set to face after Covid-19, the country’s precarious fiscal position and the question of its sustainability has become more relevant than ever.
Context on the IMF and why it is matters?
The IMF was established in 1944, when founding nations met in Bretton Woods, New Hampshire, with the objective of establishing a new economic order. After the devastation of World War II, there was global consensus that an economic overhaul was necessary to end destructive policies and prevent similar conflict from occurring in the future. As an important component of the new Bretton Woods regime, the IMF was created alongside the World Bank – with the purpose of fostering international monetary cooperation, economic stability and the sharing of economic prosperity. Over time the IMF has pursued the above by what the organisation terms as: “keeping track of the global economy and the economies of member countries, by lending to countries with balance of payments difficulties and by giving practical help to member nations”.
Mixed emotions regarding the IMF’s approach
When it comes to lending and growing economic capacity within developing economies, the organisation has for years been criticised as being a “wolf in sheep’s clothing” and at times has even been portrayed as a “rich countries’ club”. The latter accusation is a reference to the fact that voting control is skewed to the most dominant developed world economies, as a result of subscription quotas or membership fees (which are proportional to economic size and strength). The US and Europe have effectively managed the two institutions since inception, with the US traditionally leading the World Bank, while the IMF is usually led by a European representative (headquarters for the twin institutions is based in Washington). The criticism of the IMF’s approach, however, has mostly been aimed at whether the fund has truly facilitated upliftment and whether loan programme participants are afforded the opportunity to use funds for productive spending - and ultimately for debt reduction.
Historically, strict conditionality has applied to receiving an IMF loan. Critics have cited that these conditionalities have been aligned with the political interests of neo-liberal and developed world economics, with developing and poor economies suffering as a result. In recent years, this theory has become increasingly relevant with the establishment of the BRICS New Development Bank - which no doubt poses a threat to the dominance of the IMF and the World Bank. IMF loans have often been underpinned by high interest charges and austere policy requirements – including tight monetary policy, slashing government debt and decreasing social spending. In addition, central banks and SOE’s are often privatised and made separate from government, with labour rights consequently taking a hit as power shifts from unions to employers. It is no wonder the IMF has been a bone of contention amongst local politicians and economic commentators – not just would the above policies naturally lead to mass job losses in the immediate term, but discussions around local SOE privatisation and the independence of the Reserve Bank have been a political hot potato for several years.
Consequently, the above issues raise some important questions - do IMF policies leave countries too dependent on debt refinancing? Or has the IMF perhaps become a convenient scapegoat, in the wake of inappropriate policies and reckless spending? Are the typical economic candidates for these loan programmes so far gone that short-term pain may be necessary to allow for potential longer-term productivity, and could these reforms lead to an offsetting capital inflow from investors?
IMF lending programme success
The difficulty in determining the success of IMF funding programmes lies in the fact that there is usually no alternative scenario with which to compare the interventions. Countries that approach the fund for assistance, most often do so as a last resort - how do you measure the programme’s success or failure, when the alternative is likely economic collapse? Although there may not be a straightforward answer to this, we can make use of appropriate case studies to gauge the circumstances that may accompany or indeed follow an IMF funding programme.
Even those in support of the IMF are mostly willing to concede that loan conditionality in the early years of the fund’s existence were overly dogmatic, and strict policies were often applied to loan recipients in a blanket fashion – with very little consideration for the country’s unique circumstances or requirements. In more recent times, however, there has been a shift in approach from the IMF. The fund has become more lenient regarding borrowing costs as well as acknowledging each nation’s unique policy requirements. Proponents of the fund’s value-add often use examples such as Mexico and the Asian crisis of the 1990s to demonstrate that the IMF funding programme does indeed have success stories. In 1995 Mexico successfully paid back a loan of approximately $52 billion, which assisted in lifting the nation out of a certain financial crisis; while South Korea is arguably the best example of an economy which not only managed to emerge from the Asian crisis, but went on to grow into the developed economy it is today – albeit that a large part of that transformational period was under the watch of a military dictatorship.
Critics have contended that the after-effects of an IMF debt-cycle leave countries worse off than before, particularly impoverished countries. One of the most acclaimed proponents of this view being Nobel Laureate, Joseph Stiglitz (who himself chaired the World Bank from 1997 to 2000) – in his 2002 book, Globalization and Its Discontents, he famously accused the IMF of playing an instrumental role in the failure of developmental economic policy. This view took on a centre stage when the Eurozone debt crisis of 2010 arrived, and the IMF provided funding to a Eurozone nation for the first time. Arguably, this could provide the grandest case study for the fund’s effectiveness in future. Currently, however, the predicament that Greece finds itself in, would not be an endorsement for the programme’s effectiveness. Although the nation has paid back most of the $300 billion provided since the Global Financial Crisis (GFC), Greece remains heavily indebted at 180% of GDP (now mostly owed to the EU). With stubbornly high unemployment levels and yet another recession on the horizon – creditors insist that a strict budget surplus be maintained.
With around 90 different funding programmes since the GFC, the IMF has engaged with 11 countries which have gone on to rely on IMF aid for at least 30 years; 32 countries had been borrowers for between 20 and 29 years; and 41 countries have been using IMF credit for between 10 and 19 years. Although not conclusively attributed to IMF conditions, these numbers aren’t exactly encouraging for countries who can no longer rely on their own budget.
So, is SA about to join the club?
Although recent developments have increased the likelihood of needing assistance from the IMF (or an alternative funding institution such as the New Development Bank) in future – it should be noted that we are not yet at the point of no return. What the above-mentioned developments have done, is to dramatically hasten the need for serious structural reforms. Political resistance towards these reforms have been well publicised – and getting the required cabinet support has at times seemed like mission impossible, given the balance of powers within the ANC and the potential impacts mentioned above. Fortunately, however, it seems as if this scenario may be changing. Covid-19 may in fact have a silver lining, as the crisis has emphasised the extent of how cash-strapped we are as a nation; while the potentially daunting conditionalities which may accompany an IMF bailout (of which many are in strong conflict with traditional ANC ideologies) seem to be providing President Ramaphosa and Minister Mboweni with the ammunition they needed, to pass through the reforms which would otherwise have required precious time and very astute politics on Ramaphosa’s part.
From a fiscal standpoint, our debt problems remain disheartening – considering that our debt to GDP hovers around the 60% level. Coupled with a budget deficit of over 6%, there are already definite similarities with nations who have accepted loans from the IMF. The likes of Argentina, as a recent example, had similar total debt levels when approaching the fund. Importantly, however, the South African economy can also be differentiated from many of the countries in this club, in certain aspects. Firstly, there is foreign currency debt as a proportion of total debt. We have approximately 12% of our debt denominated in foreign currency, which compares favorably with other countries who have needed IMF interventions previously (for comparative purposes see below graph). Foreign currency debt is one of the most prominent causes of a crisis. Largely brought about when coupled with high inflation and significant depreciation of the local currency – the lending country becomes unable to repay their ballooning hard currency debt obligations.
Source: ABAX Investments, January 2020
Another important differentiator is the nature of South Africa’s debt maturity profile. Despite the obvious shortcomings within our budget, deficits have mostly been financed via longer-term dated bonds, which significantly alleviates pressure of any immediate payment required. The average weighted term of the foreign debt discussed above is approximately 10 years, largely thanks to the structure of our bond market – the South African fixed income market has one of the longest maturity profiles in the world, with the ability to issue debt out to 30 years. This ensures less refinancing risk in the case of debt obligation roll overs.
Lastly, astute monetary policy implemented by an efficient and expeditious South African Reserve Bank (SARB) in recent years, means that inflation has been kept in check. With the luxury of having offered attractive real yields to global investors, and the need for monetary easing as a result of the coronavirus fallout - the SARB was recently afforded the optionality to cut rates by 200 basis points, without compromising on its inflationary mandate. With repo rates now at historic lows of 5.25%, there remains some breathing room, with inflation comfortably within the target bands.
Despite the differentiators discussed above, we cannot side-step the reality that we will likely experience double digit deficits in the coming year (largely due to the global recession brought on by Covid-19). As a result, future debt levels are likely to be significantly higher than Treasury has forecasted in the most recent budget. And as a result of the most recent Moody’s downgrade, our debt refinancing costs will now be higher than in the past. Knowing that these conditions will create a challenging environment in which to generate economic growth, let alone the level of growth we need to deliver budget surplus - the drastic need for reprioritised government expenditure has become evident to all stakeholders involved (unions included). Furthermore, with the recent announcement by President Ramaphosa, detailing the largest ever economic stimulus package rolled out in South Africa – the R500 billion Coronavirus response package is expected to be largely fiscally neutral, but the majority of funds will likely need to be sourced from outside the current budget, via a combination of the SARB, private bank leverage, tax deferrals, international funding institutions and the Unemployment Insurance Fund – a daunting reality is now upon us. If spending, and by implication the public wage bill, is not substantially lowered in the next few years; we are living on borrowed time, and our country will soon be dependent on international institutions like the IMF, the New Development Bank and World Bank for more than just health care assistance (discussions are already taking place between Treasury and the above-mentioned institutions, regarding the potential for unconditional loans, aimed exclusively at combatting the health effects of Covid-19).
Although it may be a complicated task to deduce whether international funding programmes are effective or not, history has at least provided us with one helpful and straightforward insight. Either you reform the economy on your own terms, or someone else will come along and do it for you. And regardless of which institution may be most willing to open its doors to us, it would probably be in our best interest to avoid knocking for as long as possible.
Dean de Nysschen is a Research & Investment Analyst at Glacier by Sanlam
Sources:
International Monetary Fund
World Bank
Council on Foreign Relations
The Daily Maverick
The Mail & Guardian
Prudential Investment Managers
Deutsche Welle Business
ABAX Investments
Anchor Capital
National Treasury