Debt is a dirty word in our public discourse, specifically as it relates to public finances. The country is borrowing too much and the debt-to-GDP ratio is simply unsustainable, or so the ongoing conversation goes.

The other dirty word, of course, is ‘default’. God forbid South Africa do that, or the International Monetary Fund (IMF) will come knocking on our fiscal doors and take over our public finances. And so our economic Armageddon will ensue.

The debate is complicated further by speculation about whether Moody’s Investors Service will condemn South Africa’s sovereign credit rating to speculative grade or so-called junk status. Some say it’s a question of when, not if, Moody’s will downgrade South Africa.

The main dread factor is the country being booted out of the Citigroup World Bond Index. The country has been on that index for nearly seven years. It will be officially seven years in October, as South Africa joined that exclusive club in 2012. The main factors cited for inclusion were “size, credit quality and lack of barriers to entry”, according to a Citi press statement released around that time, congratulating South Africa on its inclusion. It was also the first African bond market to gain entry into the index.

Pomp and prestige were rightly the order of the day. From a reading of what was written about this occurrence at the time, this historical milestone was supposed to provide the impetus to drive the country’s infrastructure plan.

But times have changed. So, too, have the tone and the tune towards South Africa’s fiscal matrix. Market sentiment has shifted quite considerably in the opposite direction, with speculation rife that a default will be an unavoidable eventuality, given the state’s precarious finances.

The standard gauge that is used to measure this is the debt-to-GDP ratio. There is no doubt that the current economic environment has given rise to untenable conditions for most South Africans. However, that is not the focus here. The cut and thrust of this piece is to locate where the panic stems from about the country’s debt and if it is, indeed, warranted. Put another way, this is an observation of what experts in the field have written about what happens in the event of a sovereign default and its correlation to national debt levels.

In September 2018, Julianne Ams, Reza Baqir, Anna Gelpern and Christoph Trebesch co-authored Chapter 7 of a series of papers presented at the IMF’s conference, Sovereign Debt: A Guide for Economists and Practitioners. Ams et al’s chapter looks at sovereign default and in it, they contend that the current framework for locating this phenomenon sows more confusion than it brings clarity. They propose that the current definition of default is problematic and that, as it stands, it is a grey area which requires clearer definitions.

In the current framework, a default can denote any number of factors, from minor infractions to debt distress. To counter this, the co-authors have put forward three definitions of default: Technical default, contractual default and substantive default. A technical default would entail a minor covenant default; a contractual default would involve non-payment of more than 30 days; and a substantive default would be characterised by distressed restructuring with haircuts, according to the paper’s co-authors.

“Overall, there is a consensus that defaults do hurt the conditions under which governments can borrow… but there is disagreement around how persistent this effect is. For example… [a] survey by Panizza et al (2009) indicates that defaults increase borrowing costs (risk spreads) markedly, but only in the first two years post-default. Similarly, Gelos et al (2011) document that most defaulters regain access to international markets within just one or two years after a crisis. These findings are in line with older studies and suggest that investors have short memories,” observe Ams et al.

“In contrast, more recent work by Cruces and Trebesch (2013) and Catao and Mano (2017) account[s] for the severity of default, measured by the size of haircuts or the length of the default, and find evidence for a more persistent, sizeable default premium, of 200 basis points, and a longer exclusion period from international markets,” note Ams et al in their paper.

French economist Marc Flandreau focuses on digging deep into the historical record of sovereign debt and defaults, stretching back to the antecedents of the bond market.

Incidentally, Flandreau was one of the discussants of a paper titled Public Debt Through the Ages, which was presented at the September 2018 IMF conference. He made an interesting contribution to the Bank for International Settlements’ (BIS) Paper 72, exploring Russian sovereign debt pre-World War I.

His main observation is that the historical record shows that some of the sovereigns which had investment-grade ratings pre-war were the greatest defaulters when the crisis hit; while those falling in the speculative-grade fared better. It’s a peculiar occurrence, and Flandreau notes an instance of a sovereign credit rating agency adjusting its scales and views after the fact, long after the damage had been done. It is important to note, however, that he does not dismiss sovereign credit rating agencies wholesale, but merely points out the limitations of their methods.

The topic is complicated and nuanced. So much so that a lot of literature is coming on the subject, some of which includes: The National Bureau of Economic Research’s working paper on Optimal Sovereign Default on Domestic and External Debt; and Harvard Business School’s working paper on Fiscal Rules and Sovereign Default. All this work and these papers help bring perspective to the conversation.

In recent years, developed Group of 20 (G20) countries have historically carried more debt than emerging-market G20 states. At one point, Germany’s debt-to-GDP ratio was 80%. The notable exception of this dynamic, according to existing literature and case studies, is that the developed economies tend to be more resilient to market shocks and volatility because of prudent fiscal management and macroeconomic policies. And therein lies the rub for South Africa; national debt was intended to form part of a broader mix of instruments to advance the aims of a developmental state, with infrastructure development at the core.

However, fiscal decline, a scattered approach to macroeconomic policymaking and endemic maladministration all round, both public and private, have stymied the country’s progress on that score. And, by default, the debt panic shall heighten because of current economic conditions, the lack of progress in the infrastructure plan and increased borrowing in the absence of fiscal discipline. BM