The Covid-19 pandemic will exact a heavy toll on the South African economy. While by no means a foregone conclusion, the likelihood that South Africa will need financial assistance from the International Monetary Fund (IMF) or the World Bank - or possibly both - has increased sharply.
Economist Dr. Malan Rietveld weighs in on how World Bank and IMF support works.
- Why is it becoming more likely that SA would need to seek assistance from the IMF and World Bank?
The South African economy was already in bad shape before the devastating shock of Covid-19. Economic growth was lackluster and the long-term deterioration of our public debt trajectory was accelerating at an alarming rate, not least due to the liabilities and losses of troubled state-owned enterprises. Therefore, we confront the economic destruction that the Covid-19 pandemic will inflict on South Africa from a position of considerable weakness.
The economy now faces its strongest headwinds in decades, with a credit-rating downgrade, a weakening Rand and rising debt-servicing costs, as global investors shun higher-risk emerging market bonds. It has become increasingly expensive to finance our “twin deficits”. In the first instance, we have a budget deficit, which is the shortfall of government revenue relative to spending, which will almost certainly exceed 10% of GDP next year. Second, we need to finance our chronic current-account deficit, which is our shortfall of export revenue relative to what we pay for imports.
For many years, we paid for these deficits with capital inflows into our financial markets, particularly our government debt markets. The interest on these debts have been already been creeping up in recent years, and how have now risen dramatically with the Covid-19 crisis. Overall, the outflow of investor capital from emerging market is roughly 4 to 5 times as severe as it was in the aftermath of the 2008 global financial crisis, as investors seek out “safe-haven” dollar and euro assets; and fear the economic and public health impacts on emerging markets will be more severe than what we are currently seeing in developed countries.
While all major emerging markets are affected, South Africa is one of the hardest hit – in large part because we were already vulnerable before the pandemic hit. We are getting close to a point where market interest rates become prohibitively expensive and simply absorb too large a share of government spending at the expense of all other needs. This is where potential assistance in the form of a loan from the IMF comes in.
As regards the World Bank, the South African government has talked about making use of its emergency funding facilities to pay specifically for the significant increase in expenditures on public health, such as the procurement of test kits, and increased laboratory and hospital capacity.
2. When do countries typically turn to IMF and World Bank?
The IMF’s financial assistance is focused on helping countries with essentially two types of payment shocks. The first relates to countries’ external finances: the balance of their trade and capital flows with other economies. Economists call this the Balance of Payments. In the South African case, we import more goods and services than we export, hence we run a current-account deficit – and we pay for that with inflows of foreign investor capital into our financial markets. The second kind of problem that IMF assistance aims to address relates to budget deficits and long-term fiscal sustainability. In an economic crisis, the cost of paying for both current-account and budget deficits can shoot up dramatically, so countries go to the IMF to seek lower-cost financing than what is on offer in market.
The World Bank’s lending and investment activities are aimed at directly supporting public expenditure needs that are essential to long-term economic growth and development, such as infrastructure, healthcare and education.
3. What form could financial assistance from the IMF take?
The IMF has a wide range of lending facilities. At the one of end of the spectrum are emergency, non-concessional credit facilities offered to all IMF member countries through the General Resources Account. At the other end, the Fund also provides concessional financial support (currently at zero interest rates through June 2021) through the Poverty Reduction and Growth Trust, targeted at low-income countries and providing a longer window for (interest-free) repayment.
Within these two lending windows there are various instruments and facilities, allowing the IMF and recipient countries to negotiate and tailor a support package with varying durations, repayment schedules – and, most controversially, the strings attached to the loans in terms of economic policy and structural adjustments required by the IMF in order to improve the creditworthiness of crisis-hit countries.
4. And the World Bank?
The World Bank has an even larger range of financial tools than the IMF, including grants, concessional loans and even equity investments in infrastructure and private companies. But most relevant to Covid-19-related public expenditures will be its lending programmes. In addition to its two standard loan models – investment loans for projects with a 5 – 10-year horizon; and “development policy loans” with a 1 to 3-year horizon in support of policy and institutional reforms – the World Bank has the ability to disburse loans very quickly during times of crisis, through its Fast Track Facility.
This facility shortens the World Bank’s typical loan-negotiations and -approval process, and highly concessional terms and repayment options to disaster-struck developing countries. The World Bank has stated it expects to provide a staggering $160 billion in financial support over the next 15 months to aid the global response to the pandemic.
5. Why have engagements with the IMF attracted so much controversy?
The big issue with IMF lending, historically, has been the strings attached to them. Most obvious is the requirement that recipients make a series of macroeconomic adjustments, such as cuts to government expenditures (read: public-sector wages) and market-friendly reforms to the tax structure, the privatisation of state-owned enterprises, financial-sector liberalisation and the breaking up of government-operated monopolies.
The bigger and longer the loan, and the more concessionary its terms, the more relevant this issue becomes. It is possible that South Africa could approach the IMF fairly soon and negotiate a relatively short-term, non-concessionary loan – simply as an alternative to financing our twin deficits exclusively through the bond market, under the assumption that current market interest rates are extraordinarily punitive.
The catch is that it is questionable whether South Africa’s economic malaise is really temporary and Covid-19 driven, and whether we will earn a reprieve from the bond and currency markets in the next year or two. Sure, the pandemic and its economic impact has made things much worse and massively reduced our ability to fix things, even if our policymakers had the political will do so. But even when the economic shock of the pandemic passes, the issues that ailed our economy before – low economic and productivity growth, unsustainable debt and commercial fundamentals at our state-owned enterprises, a lack of export competitiveness and long-term fixed capital investment, a bloated public sector workforce and wage bill – will still be there.
We may therefore ultimately require a much larger and more comprehensive IMF programme, which will certainly come with demands that these politically sensitive reforms are initiated. That will be controversial – after all, South Africa has failed to kickstart any meaningful economic reforms for decades now, precisely because of political difficulties and resistance from vested interests in doing so. But once we reach the point of being essentially shut out from the bond markets – due to excessive interest rates and debt-servicing costs – we will have very few alternatives. It is not inevitable that we will get to that point, but the odds are increasing with each passing day.
6. What are the likely next steps with respect to the South African government approaching the World Bank and IMF?
South Africa would have no difficulties qualifying for a World Bank loan to help pay for a temporary and acute increase in expenditures in public health. If, as one might expect, the South African government wants the money soon, it could use the Fast Track Facility window, without any controversy and problematic strings attached to the loan. I would think the government should waste no time getting this process started, which is why the initial request for $60 million from the World Bank for healthcare expenses to fight Covid-19 is the right thing to do and probably the first of many such requests.
The IMF process is more complicated. We could go early and seek a short-term loan, which would not be particularly concessionary but also not require structural or policy reforms. Or we could wait a number of months and hope that the tide miraculously turns. If it does not, we would need a bigger and more controversial IMF programme, which will come with requirements for structural reforms. At this point, the political messaging from the ANC alliance partners has predictably been anti-IMF. Even Ministry Tito Mboweni is expressing a preference for immediate World Bank support for healthcare expenditures over IMF assistance, arguing that we do not (yet, at least) need IMF support. There is a lot of posturing and face saving behind these comments, and they are part of the complex political dynamics that precede any country’s reluctant approach of the IMF.
The IMF understands the desire for such reforms amongst key leaders and policymakers, so I personally believe it is likely South Africa will be able to negotiate a reasonable timeframe for the implementation of reforms, should a broader IMF programme be needed (most likely next year). Contrary to the comments of political opportunists, the IMF wants South Africa to succeed – and will work with the reformist camp in government on establishing a reasonable schedule, sequence and prioritization of such reforms.
* Dr. Malan Rietveld is an independent economist who has advised sovereign wealth funds and their host governments around the world.