Short-term relief will not be enough if the government does not jolt the economy into life with breathtaking reforms.

It will be many months before we are able to assess the extent to which the Covid-19 pandemic has damaged the global economy. An unprecedented supply and demand shock has already led to a projected 16% unemployment rate in the US, the world’s biggest economy, with 26-million unemployment claims last week alone. This is four-and-a-half times more than the February 2020 unemployment rate. If this continues, the US unemployment rate will reach levels not seen since the Great Depression in 1934.

The International Monetary Fund (IMF) believes the global economy will contract 3% in 2020 — the worst global recession since the Great Depression. Dramatic reductions in supply and demand, falling commodity prices, outward capital flows and declining global growth all contribute to this. The fragility of many economies is evident, with developing countries suffering from an unhappy combination of a health, financial and fiscal crisis. SA is no exception.

While the lockdown here was incrementally eased from May 1, it is expected that months of restricted business activity will greatly weaken an already fragile economy, which contracted 1.4% in the last quarter of 2019. A widening budget deficit (projected by the IMF to reach 13% of GDP for 2020, four times the EU limit), increased levels of government borrowing (forecast to be 77% of GDP), the ongoing absence of microeconomic reforms and unsustainable state-owned enterprises (SOEs) have all contributed to this. Deep structural issues inhibiting growth, combined with the profligate debt accumulation and rapid capital outflows, have resulted in the government running out of fiscal space at a time when additional spending is needed to combat the pandemic.

It is in this context that the government’s announcement that it would seek funding from the IMF to deal with Covid-19 is so important, notwithstanding the ANC’s historical aversion to Bretton Woods institutions. There is a simple reason for this: the financial firepower of the IMF, with its $1-trillion lending capacity, dwarfs anything any other international financial institution can offer.

To avoid extensive conditionality as well as to access funding quickly, SA will most likely use the fund’s rapid financing instrument (RFI), which provides rapid low-access financing to member countries facing urgent balance of payments needs. Funding provided under an RFI is usually subject to minimal conditions and offers low interest rates (about 1%). This type of facility is often used in cases where an economy has suffered exogenous shocks with temporary or limited effect, and where comprehensive economic reforms are either unnecessary or impractical.

Assistance given under an RFI is in the nature of an outright loan (defined as a “purchase”), which is not accompanied by a fully fledged structural adjustment programme. The borrower is simply obliged to co-operate with the IMF by addressing balance of payments difficulties and providing information on the economic policies it proposes to implement. Repayment is due in between three-and-a-quarter and five years.

Borrowing under an RFI is normally based on a country’s balance of payments needs, its capacity to repay, the existence of outstanding credit and the country’s historical record with IMF resources. This, in turn, is linked to a country’s special drawing rights (SDRs), the IMF’s currency instrument, which is built from a basket of national currencies including the dollar, euro, yen, yuan and pound. These SDRs represent reserve assets that member countries may borrow subject to their allocated quota (denominated in SDRs) as well as any access limits applicable to specific lending instruments.

Historically, borrowing under an RFI was limited to 50% of a country’s SDR quota. Higher access limits have, however, been temporarily put in place to accommodate Covid-19 related financing needs, increasing from 50% to 100% of quota per year, and from 100% to 150% of quota on a cumulative basis (net of scheduled repurchases). SA’s quota is just over SDR3-billion (equivalent to $4.2bn). If SA’s RFI application is granted, $4.2bn would obviously go a long way towards addressing the country’s fiscal gap and the immediate cost of Covid-19.

Because of the limited conditionality associated with RFIs, it is a politically palatable instrument for those concerned about the alleged predations of international finance institutions on developing countries’ policy space. While the immediate concerns about an economic crisis have generated sufficient political impetus to enable the government to approach the IMF for short-term relief, it is clear that this will be insufficient to address all the underlying issues that have bedevilled SA’s economic growth during and after the lost years of the Zuma administration.

One question that has not yet been adequately answered is how the proposed $4.2bn facility will be repaid in the period 2023-2025 given SA’s economic trajectory. Ratings agency Moody’s Investors Service recently indicated that it foresees the economy entering a recession and GDP contracting 6.5% in real terms in 2020.

It is for this reason that some have drawn attention to the country’s imminent fiscal cliff: faced with declining fiscal revenue, unsustainable borrowings and an unmanageable fiscal deficit, the government could be forced to seek additional long-term assistance from the IMF in the form of either an extended credit facility (ECF) or standby arrangement (SBA). These facilities will be subject to more extensive conditions than an RFI. In particular, an ECF or SBA is typically conditional on the implementation of extensive structural reforms aimed at addressing microeconomic challenges and raising the country’s long-term growth trajectory.

A full SBA with normal access up to a cumulative limit of 435% of quota would give SA about $18bn over the course of this financing arrangement. Unlike the RFI, accessing financing under an SBA would be subject to structural reform conditions, which, based on the IMF’s last Article IV report on SA in January, would require it to implement “strong fiscal consolidation and SOE reforms to ensure debt sustainability”, accompanied by structural economic reforms comprising “product and labour market reforms, including greater competition and private participation in network industries”.

In non-IMF speak, this means opening up the product market through greater trade liberalisation, introducing labour market reforms and removing the state’s monopoly, through Transnet and Eskom, over ports, rail and electricity while introducing private sector competition to all of them. Implementing some (or all) of these measures would undoubtedly be an electric shock to a somnolent economy.

In recent years the IMF has responded to developing country criticism of its structural adjustment programmes by providing somewhat greater policy flexibility (as it did with Serbia in 2015). In the IMF’s 2018 “Review of Programme Design and Conditionality”, the executive board stressed the importance of promoting public acceptance and national ownership of structural reforms. As the board indicated, this emphasised the need to build expertise in shared areas of responsibility such as labour, product and financial market reforms, which are key to competitiveness and private sector-led growth.

Ultimately, SA is master of its own destiny, whichever course it decides to take.

This Op-ed was first published in Business Day on 3 May 2020, you can view it here

For more information, please contact Peter Leon or your usual Herbert Smith Freehills:

Peter Leon
Peter Leon
Partner and Co-Chair of Africa Practice Group, Johannesburg
+27 10 500 2620