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South Africa’s cliff scenario: an early prognosis

Kurt Davis Jr.
By Kurt Davis Jr.
Investment banker

Kurt Davis Jr. is an investment banker focused on Europe, Middle East, Africa, and Turkey and is a member of the Council on Foreign Relations. He earned an MBA. in finance, entrepreneurship and operations from the University of Chicago Booth School of Business and a J.D.. in tax and commercial law at the University of Virginia’s School of Law. He can be reached at

Posted on Wednesday, 19 February 2020 07:56

The writing is on the wall. If South Africa’s economy does not take a turn for the positive coupled with some tough economic reforms, the country could face an Argentina-like future.

Recent bailouts, including of South African Airways, will push South Africa’s debt ratio above 70% of GDP by 2023 with an estimate of 59.7% in the February budget.

This number will rise to 80.9% in 2028, according to the National Treasury in its recent medium-term budget policy statement published in October. Previous projections estimated 60.2% in 2024, before declining over time.

To be fair, these numbers are better than Argentina’s.

Government debt is north of 90% of GDP in Argentina – the highest level since 2004, when the ratio reached a high of 116% of GDP. Argentina sovereign bonds have fallen to less than 50 cents on the dollar.

READ Eskom woes cast long shadow for South African mining

On the other hand, state-owned companies, such as Eskom and Transnet, and South African sovereign debt, both trade, at worst, in the high 70s with most trading at par.

The South African debt numbers do not necessarily terrify officials.

On the face of it, the sovereign (and sovereign-related) debt prices are nowhere near Argentinean levels and the debt to GDP ratios today are not far beyond other African countries, including Kenya, Ethiopia, and Ghana for example.

But the difference in this situation is the ‘falling off the cliff’ scenario and the tools available to the South African government to combat such a scenario.

Falling Off the Cliff…

There is enormous uncertainty over the direction of the South African economy in the next 12 months. Business confidence in the country rose with the arrival of President Cyril Ramaphosa, particularly as his business acumen was contrasted against that of Jacob Zuma

READ Ramaphosa fails to show leadership as difficult and decisive year looms

Now, more than a year into the Ramaphosa era, that confidence bump has been lost to the daily barrage of economic turmoil stories.

The placement of South African Airways in the Business Rescue Process (a South African version of bankruptcy) with bailout money from the government has all but underwritten the growing fears of an investment downgrade by Moody’s for South Africa.

Any further slippage by Eskom beyond the already normalised load shedding and Moody’s may be forced to take the hard decision (which many analysts believe the rating agency would like to avoid).

READ Inside the SAA crisis: airline needs more than R2bn to stay afloat

Now, while the market has significantly priced its expectation / outlook on a Moody’s downgrade, it remains quite challenging (and maybe impossible) for a market to truly and completely price and value a non-investment grade South Africa.

Any estimate or view remains a precarious one with a couple of questions hanging over the entire situation:

  1. What becomes of the political situation if capital runs for the doors? And what is Ramaphosa’s job security (even if he did not create today’s problems)?
  2. Is the economic and legal ecosystem in South Africa ready for the trades and economic plays that investors, including foreign and local distressed investors, will take?

To further demonstrate the uncertainty of projections in the similar situation, consider the International Monetary Fund (IMF) was estimating in 2017 a less than 10% probability that Argentina would encounter a debt to GDP ratio above 70%.

As previously mentioned, Argentina is north of 90% today.

This only highlights that those smart economists and analysts have the best data and analyses but sometimes cannot perfectly account for drastic turns in a local economy, especially when it is accentuated by plummeting business confidence and the associated business and consumer behaviour (i.e., less consumer spending) that comes with that business confidence drop.

READ Aberdeen Asset Management sees Moody’s delaying on South Africa until November

Economic Tools for South African Leadership

The drop in business confidence cannot be overstated in the South African context.

First, South African talent is exiting the country:‘white’ flight is Indian, black, and coloured. In other words, the talent pool that could be South Africa’s next generation of business leaders, entrepreneurs and political leaders are already betting on far-off lands rather than their home country.

This is a major shift as South Africa was once an attractive career location for locals and foreigners alike.

Secondly, investors have (and will continue to at a greater rate) dump the South African currency and debt.

The natural outcome of this is a weaker exchange and higher yields, which generally hurt the government’s ability to service its debt.

Third, it is not exactly clear if investors have the same love for South Africa as they do for Argentina.

Investors returned to Argentina after 2004 and 2005 and (surprisingly) remain interested in the South American country after it defaulted.

It is not clear if investors will have a similar affinity to return, at least as quickly, to this southern African country if any major economic ‘cliff fall’ event happens.

The slow steady drop in confidence, despite small upticks (i.e., Ramaphosa’s entry into the presidential office), has been ongoing for a while and, at this stage, any bad news is ultimately expected and further pushed along by investors and consumers rightfully pulling back from the country…in other words, the country is in a stage of self-fulfilling prophecy relating to bad news.

The government cannot improve business confidence with one quick policy modification.

First, it is not clear any government can make a quick policy change that creates economic confidence.

The Trouble Asset Relief Program (TARP), signed into law by President George Bush in October 2008 and later implemented by President Barak Obama’s administration, took so much ‘behind-the-scene’ hand wrangling and negotiation despite the magnitude of the global add-on effect if it failed.

It says nothing about South African politics to say that a quick policy change would likely not be possible. Most analysts already suggest that businesses and unions would both need to give great concessions in a new economic plan…this is not a ‘water under the bridge’ situation between these two blocks of the economy.

In a ‘cliff fall’ scenario, South Africa may have to turn to the IMF for help, which would ultimately entail significant reprofiling of the country’ sovereign (and sovereign-like) debt coupled with very steep changes to the economic infrastructure and workings of the country.

Again the latter would require a deep-dive into South African politics and rewriting the rules (in theory) of how the politicians engage with the public and which promises it can truthfully make to its populace.

Social programmes, for example, would feel some pain with the greater pain potentially falling upon the country’s poor. That said, the politics are too difficult to lay out in short form here.

Reprofiling the debt would be an uphill battle.

The government could only reprofile debt (in conjunction with the IMF) if the debt were sustainable (as part of IMF guidelines).

Thus, the question becomes what is sustainable, which is a tough question considering the market will ultimately reprice the risk in the country and opinions will significantly diverge on what is sustainable.

Economists and analysts already think the debt is not sustainable for the state-sponsored entities…the loudest voices in those groups already think 50%-plus of the debt will have to be cut from the balance sheet.

It may seem crazy (and possibly out-of-place) to be taking an early view on a South Africa downturn.

But the problem has been brewing for years.

Economists and analysts have been discussing this for a while in backrooms, clearly with more angst in recent months.

The sad reality is that there may be more confidence in the downturn than there is in any uptick or rebound prior to a cliff scenario let alone after it.

All this bad aura and feeling seems such a far cry from Mandela’s early days.

But those days should remind us that the Rainbow Nation is capable of great changes and turnarounds in a short period and that the first step may simply be having hope and confidence in the country’s ability to do such and allowing / having leaders take the necessary steps to forge ahead.

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