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SA ON A CLIFF EDGE

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CURRENT developments in South Africa are reminiscent of events in 1985. In that year South Africa experienced high costs from currency depreciation and adverse political developments.

At the time the country faced increasing international sanctions and isolation, while the exchange rate of the Rand remained under severe pressure, recording sharp falls in the international value of the Rand.


South Africa’s financial stability was put under severe pressure after the infamous Rubicon speech of then President P W Botha. Before the speech, high expectations were raised internationally about the announcement of major political changes in South Africa, but these expectations did not materialise. Following the speech, foreign banks refused to roll over South African short-term foreign debt, causing further depreciation of the exchange rate of the Rand.


In 2017 South Africa might see a slow motion repeat of the events of 1985, culminating in a debt standstill. This time we can see trouble ahead and the government should act responsibly to avert a slow motion replay of 1985.


Currency depreciation brings certain benefits to a country. The most obvious is the fact that exports become cheaper abroad and that demand for exports are therefore stimulated. Unfortunately currency depreciation does not only bring benefits. Imported goods and services also become more expensive. More expensive imports put pressure on domestic inflation that can result in increases in interest rates. In economics it has often been said: “There is no free lunch, everything has a cost, even if then only an opportunity cost.”  Currency depreciation also increases the capital value of foreign debt in domestic currency and the interest burden on such debt, as interest is also paid in foreign currency.


In short: in 1985 an unwillingness of banks abroad to make loans to South African entities plus the depreciation of the currency resulted in the inability of the country to repay its foreign debt.
The financial crisis culminated in the ‘Debt Standstill’, a moratorium on the repayment of most of South Africa’s private sector foreign debt, but excluded government debt. Debt repayments were managed by a Debt Standstill Committee and rescheduled over an extended time period, with the last of the rescheduled debt repaid in 2001.
In recent months the exchange rate of the Rand has shown considerable depreciation. This is actually an acceleration of a long-term declining trend.
In assessing the ‘Debt Standstill’ with the benefit of hindsight, it is important to distinguish between South Africa’s foreign debt and South African government debt, as only private sector foreign debt was caught in the standstill.
The country’s foreign debt is all funds borrowed abroad by South Africans, including companies, other entities and private individuals and includes the government’s foreign borrowing. By the middle of 2015 South Africa’s foreign debt amounted to some R1.7 trillion, of which 46 per cent was denominated in foreign currency.
South Africa’s foreign debt naturally includes the portion of the South African government debt borrowed abroad, comprising about 11 per cent of the country’s foreign debt. The balance is supplier credit, trade credit and the like. For instance: if a foreign supplier sells to a South African company and provides a six-month credit line, the credit line is part of the country’s foreign debt for a period of six month.  Since 2007 South African foreign debt has shown a steady increase as percentage of both the gross domestic product (GDP) and total export earnings (TEE). At the same time interest payments on foreign debt as percentage of TEE have increased.
South Africa’s foreign debt position is vulnerable in three respects. First, currency depreciation raises the capital value of the funds borrowed abroad in foreign currency, hence increasing the repayment burden on South African borrowers. Foreign debt as percentage of GDP increases owing to currency depreciation.
Secondly, interest payments on foreign debt increase owing to currency depreciation. This will be exacerbated by an international normalisation of interest rates. The result might be a raising TEE if the combined result of higher international rates and currency depreciation exceeds the increase in exports owing to currency depreciation.
These two factors were present in 1985, but were exacerbated at that time by political considerations, namely banks refusing to lend more money to South Africa after the Rubicon speech. The last element for a repeat of 1985 in slow motion might be triggered by another event some 30 years later: a credit risk downgrading to junk status of South Africa by international rating agencies. Now that South Africa’s international risk rating is downgraded to junk status, international banks and other companies will be much more reluctant to make loans to South African entities, or will even withdraw existing credit lines.
Source: Mail&Guardian

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