Interest in the topic of public finances has risen dramatically in South Africa in the wake of the Covid-19 pandemic. Some commentators have used phrases like “South Africa has hit its fiscal cliff”; South Africa is on the “road to bankruptcy”; and South Africa is facing a “sovereign debt default”. This rhetoric has arisen perhaps because our discourse on public finances has been sucked into the whirlwinds of a slightly hyperbolic debate. Much of this verbiage can be reduced, however, to a straightforward question: Is the South African government bankrupt?
The simple answer is “no, it isn’t”.
In fact, our government, given its public finance model, can’t fall into bankruptcy or run out of the ability to pay for its own operations, provided it continues to spend in a currency that it issues. The risk of bankruptcy, which is minimal at this stage, would only arise were the South African government to unsustainably incur debts denominated in foreign currencies.
Thankfully, almost all of the South African government’s currently issued Treasury bonds (what is referred to as our government’s debt) are denominated in rands. The percentage of rand-denominated bonds is something in the order of 90%. The terms by which these bonds are issued typically include the right to a claim for the interest and capital directly against the National Revenue Fund (i.e. the government’s bank account). To understand why the holders of rand-denominated government bonds aren’t facing a potential default in payment, it is important to understand how the government’s finances actually function.
How does the government’s bank account work?
The government’s account with the Reserve Bank is best understood as an accounting ledger, rather than as a conventional bank account that you or I would have at a commercial bank. In the case of the National Revenue Fund the accounting operation performed by the Reserve Bank is more akin to the creation of new money rather than the transfer of a pre-existing stock of money (which is credited to an account).
The framework for the operation of the government’s special bank account originates in the Constitution. Section 77 of the Constitution sets out the manner in which payments can be made from the account. The legal mechanics of the government’s spending are in turn set out in the Public Finance Management Act 1 of 1999.
Generally speaking, there are two avenues for payments to be made out of the government account: either Parliament passes an appropriation act which functions as a legally binding instruction to pay; or, a pre-existing legal statute permits “direct charges” being made against the account. In both of these scenarios the Reserve Bank does not have the discretion to withhold payment and is legally obligated to credit the relevant commercial bank with payment in rands.
Just like any other issuer of fiat currency, the South African government through its payment agent, the Reserve Bank, is self-financing. It issues the money it uses to make payments. The foundational issue to understand, therefore, is that the government can’t run out of its own currency.
The question then is whether the government could deliberately withhold payment in respect of a rand-denominated bond?
Can the government default on its rand-denominated bonds?
The answer in large part can be found in section 73, a little-known provision of the Public Finance Management Act. This statutory injunction immunises the holders of bonds from the risk of default as it provides that the payment of interest, capital and the associated costs of a Treasury bond are to be “direct charges” against the National Revenue Fund.
What this means is that even in the unlikely event that the South African government deliberately sought to default on any of its rand-denominated bonds and purported to withhold payment there would be a legal block. The bond holders would have a statutory claim emanating from the Constitution – to payment in rands from no less than the actual issuer of the currency namely: the Reserve Bank. Thus, even if the government wanted to default, it couldn’t ultimately frustrate a valid claim from a bond holder given the current architecture of our legal system.
What about bonds denominated in foreign currency?
This form of bond is an entirely different kettle of fish. The South African government would, in the context of foreign-denominated bonds, be in the same position as any conventional debtor – always at risk of a default if it ran out of a ready supply of foreign currency. The key point to make here is that the South African government actually has the discretion to keep the fish out of this kettle altogether in that there is no objective reason for the government to take on foreign-denominated debt.
In our current context, if there ever was a genuine fear that the South African government would struggle to meet its foreign obligations, like the Zambian government at present, then it could immediately act to:
- Discontinue any additional foreign-denominated debt being incurred by the public sector (foreign-denominated debt is generally speaking unnecessary and should in any event be avoided);
- Disallow the deductibility of interest against taxable income in the case of foreign-denominated loans owed by natural and juristic persons in South Africa; and
- Tighten exchange-control restrictions and disallow further private inbound foreign-denominated debt, preventing such instruments from lawfully being incurred by natural and juristic persons in South Africa.
The only definitive means by which the South African government could immunise all of its bondholders from the potential risk of default is to ensure that all of its bonds are rand denominated. In this regard it is helpful – and perhaps comforting – to note that only about 10% of the government’s current issued bonds are denominated in foreign currency.
An important additional consideration to take into account is the fact that the Reserve Bank reached a record level of foreign currency reserves in July of this year – meaning our country has strengthened its ability to meet its international obligations.
Since the small number of foreign-currency bonds held by the South African government are the only ones likely to raise the risk of a default and given the healthy balance of foreign currency held by the Reserve Bank as the public custodian of our country’s foreign capital, the assertion that our government is or will imminently be bankrupt is simply without merit. DM