The recent R70-billion loan by the International Monetary Fund (IMF) to South Africa has been received with mixed reviews by various segments of the country. National Treasury Director-General Dondo Mogajane has welcomed the decision, indicating that the government will ensure that it meets the loan conditions and that it has in no way compromised the country’s sovereignty or risk. 

The Economic Freedom Fighters (EFF) believes that it is one of the biggest political blunders in South African history, labeling it “neoliberal” and warning that it could undermine governance in the country.

The DA believes it represents a “watershed” moment for the country as it is the first time since 1994 that the government has had to resort to borrowing from the IMF. Highlighting the dire state of the economy and the effects of weak and corrupt governance, the DA has called for increased transparency in the management of the loan. Indeed, the IMF presented this in their statement on the loan in that they expect the government to “manage the IMF’s emergency financial assistance with full transparency and accountability”.

Accepting the loan was largely a no-brainer as not only will the IMF not impose any conditions on the country, but the interest on the loan is also small, approximately 1.1%. In economics, the interest rate is considered to be the price of money. 

With the rate that the IMF is charging on this loan, it makes it very cheap for the country to pay back. South Africa has also been granted 20 months to pay back the loan, which only kicks in 40 months after the country has received the loan. This is particularly important because it means that the country will hopefully have significantly recovered from the costs that have been incurred from the effects of the Covid-19 pandemic.

As in any situation where an individual applies for a loan, there is required to be a level of due diligence. The IMF has done this in relation to South Africa. They have evaluated the country’s economic situation, its levels of national debt, gross domestic product (GDP), its credit ratings and various other financial indicators, and found SA worthy of taking on this debt. However, expectations are that the country’s economic growth is forecast to shrink by 7%. If the economy shrinks, this directly affects the government’s ability to acquire revenue through taxes that are used to pay back these bonds.

Herein lies the challenge – the South African government has taken out a loan in a variety of foreign currencies which the country will be expected to pay back in the near future. Many of these countries are economic giants which have largely either mitigated or managed the economic fallout from the Covid-19 pandemic. They are also moving towards scenarios where they have largely reopened their economies or they intend to have their economies operating at full capacity in the face of Covid-19.

While the IMF has not imposed any conditions on this loan, the institution obviously expects that through disciplined, sound and pro-growth fiscal policy the South African government will ensure that the economy grows into the future. Although not written down and signed, this is of course the implicit agreement in the background of such deals. Of course, this is good, one would hope that the government understands a growing economy is in their best interest. If the economy grows, the tax base grows and the government can pay off debt and if needs be, it can raise more debt because of its good credit record.

One of the challenges that South Africa will face as it takes on this debt and quite possibly attempts to raise further loans in the future is a term known in economics as “original sin”. It was coined by economists Barry Eichengreen, Ricardo Hausmann and Ugo Panizza who analysed the challenges facing developing countries in raising debt. Their focus was on the fact these countries are unable to take out loans in their domestic currency and this made them vulnerable to fluctuations in global markets and transaction costs.

Take, for example, the IMF loan – it has created its own form of international money called Special Drawing Rights which essentially is a basket of currencies from the world economy. It is made up of the dominant world currencies namely the US dollar, pound sterling, the euro, the yen and the Chinese yuan. This obviously creates stability in the value of the loan in ensuring that it isn’t dominated by a single nomination and thus tied to a particular country. 

The balance created by these various currencies appreciating and depreciating against each other helps to buffer South Africa from significant changes in a single exchange rate. Assume, for example, that the entire loan was only in dollars, if the dollar increased significantly in value, this would force additional financial obligations on the country – unless, of course, South Africa was unable to secure the loan at a fixed exchange.

Herein lies the challenge – the South African government has taken out a loan in a variety of foreign currencies which the country will be expected to pay back in the near future. Many of these countries are economic giants which have largely either mitigated or managed the economic fallout from the Covid-19 pandemic. They are also moving towards scenarios where they have largely reopened their economies or they intend to have their economies operating at full capacity in the face of Covid-19.

It goes without saying that the longer a country remains in some form of lockdown, the worse it is for that country’s economy. In South Africa’s case, it has been in one of the most restrictive lockdowns globally for over four months. If the world economy starts reopening and South Africa is not set to join in as this happens, it will not only be left behind, but it could have catastrophic effects on the country’s currency. This in turn would jeopardise its ability to fund its foreign debt obligations and risk the possibility of defaulting on these payments.

It’s a simple equation – governments receive money from taxes which they use to pay off the loans that they take out internationally. Taxes are driven by economic activity, namely the production of goods and services that take place within a country’s borders. If these activities increase, the government makes more money and funds its debt. If the economy shrinks, the government has less money and risks defaulting. With the unnecessary restrictions that the South African government has put in place, it is constricting whole aspects of the economy and jeopardising its financial position, and commitment to its funders. DM