The IMF’s $4bn loan for South Africa: the pros, cons and potential pitfalls
The International Monetary Fund (IMF) has approved a R70 billion (US$4.3 billion) loan for South Africa to help the country manage the immediate consequences of the fallout from COVID-19. The Conversation Africa’s editor, Caroline Southey, asked Danny Bradlow to shed some light on what South Africans should expect.
The IMF has provided the funding through its Rapid Financing Instrument. This is designed to support countries facing an urgent need for financing due to a crisis such as the COVID-19 pandemic. The goal is to help the country face the immediate financial consequences of the crisis. As a result the IMF provides the financing quickly and without strict conditions. The country merely 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 solve the balance of payments problems caused by the crisis and to describe the economic policies that it proposes to follow.
In some cases, the IMF may require the country to undertake certain policy actions before it can access the funds.
In South Africa’s case, the country’s payments problem relates to the fact that the economy is expected to contract by about 7% this year and the budget deficit to increase to about 15% of GDP. This means that the government will need to increase the amount it has to borrow. Given that it has been downgraded by credit rating agencies, and that the economy is in bad shape, there is a substantial risk that both local and foreign investors will have a limited appetite for South African debt. This will complicate the government’s efforts to finance the deficit.
The IMF loan helps resolve this problem.
South Africa provided the requisite 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 seems to have informed the IMF that it intends to take certain steps to stabilise the country’s finances. This means that the government will cut government spending to reduce its need to borrow.
This kind of financing is provided in one payment. The IMF press statement doesn’t say when the funds will be disbursed but the goal is to make the funds available “rapidly”. That could be as early as August.
Once the funds are disbursed, the government will be free to spend them. According to the national treasury’s statement, it plans to use the money to support health and frontline services, to protect the vulnerable, drive job creation, support economic reform and stabilise public debt.
These are all consistent with the purpose of the Rapid Financing Instrument and the government’s stated intentions.
But these purposes are very general and we will need to see more detail about what exactly the government will spend the funds on.
The IMF requires that South Africa repay the funds to the IMF over 20 months beginning 40 months after the loan is disbursed. This means that South Africans will need to ensure that the funds to repay the IMF are properly budgeted for.
The most important benefit is that South Africa is getting $4.2 billion at about 1.1% interest. This is a very cheap source of funds. If the government tried to raise the same amount either on domestic markets or from other international sources it would pay a considerably higher interest rate – the current rate for government bonds of comparable maturity is about 7%.
The second potential benefit is that the IMF loan will catalyse 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. Given that foreign investors hold about 30% of South African government’s rand denominated debt this boost to confidence could be important. It will both reduce the incentive of these investors to sell their government bonds, potentially pushing up interest rates, and enable the government to issue new debt if needed.
The third benefit is that by helping to stabilise South Africa’s situation, it will limit the damage that may be inflicted on the neighbouring countries. This, in turn, could help South African exports and thus help preserve jobs and income in South Africa.
But it’s important to keep in mind that the IMF denominates the loan and the repayment obligations in Special Drawing Rights. These are the IMF’s special form of money and its value is made up of a composite of a basket of currencies. These include the US dollar, the euro, the Japanese yen, the Chinese renminbi and the pound sterling.
The second risk is that if South Africa does not use the funds from the IMF wisely, the country’s economic situation will deteriorate and it will struggle to pay back the debt.
If this happens or the pandemic lasts longer than anticipated, the country could be forced to seek additional support. In either case South Africa’s negotiating position would be significantly weaker. TheConversation.