Taboo on foreign borrowing is well and truly broken

It was a week of foreign borrowing news that would not have been imagined five years ago. The New Development Bank (NDB) approved another billion or two dollars of loans to South Africa, bringing its total South African portfolio to more than $6bn (R106..24bn). And the IMF issued a routine update on South Africa's ability to repay its $4.3bn (R76.14bn) loan from the IMF.

None of it raises eyebrows now, but it was that IMF emergency loan, in the depths of the Covid-19 pandemic in 2020, that broke the democratic government’s long taboo on borrowing from international finance institutions such as the IMF and World Bank.

Since then the government has raised more than $11bn (R194.77bn) of low-interest, hard currency loans from international finance institutions and multilateral development banks. In addition to the IMF, World Bank, NDB and African Development Bank, these include the development finance arms of the French, German and Canadian governments.

Those governments and the World Bank have advanced funding to South Africa to support its just energy transition. The loans are so-called policy loans, which recognise the steps the government has already taken on climate change, rather than setting conditions that have to be met in future.

Those loans now total $2.4bn (R42.49bn) and are directly to the sovereign. They go straight into the public purse rather than being linked to particular projects (though the World Bank also granted a project loan directly to Eskom for the decommissioning of Komati power station).

The Treasury plans to do more, with February’s budget documents pencilling in $2bn (R35.41bn) from international institutions this year and $9.5bn (R168.21bn) over the next two years to support “developmental objectives”, including the just energy transition.

The totals may look large, but they are still a tiny fraction of the government’s total debt of about R5.5-trillion, or even of the government’s total foreign borrowing, which is hardly more than 10% of its total borrowing. Most of that foreign, hard currency borrowing has historically been on international bond markets, the so-called Eurobond markets.

The Treasury has tapped those markets only twice in the past five years, placing a $5bn (R88.53bn) dollar bond issue in 2019 and raising a further $3bn (R53.12bn) in April 2022. That money is at market rates.

The other loans are at far lower interest rates for terms of up to 30 years and with grace periods of three to five years before the loan has to start being serviced. With global interest rates soaring since 2021 and the risk premium investors demanded to lend to South Africa running high until recently, those market rates were steep.

Which is why the Treasury has had a deliberate strategy in recent years of accessing concessional loans to raise hard currency instead of tapping the market at a time when rates have been so unattractive. It’s a cost issue. It is also a diversification issue. The cost of government debt has been the fastest-rising item of government expenditure, consuming about a fifth of the tax revenue it raises. Markets have been demanding particularly high yields or rates on long-term loans to the government because of their scepticism about the outlook for the public finances and about South Africa's political outlook.

The Treasury has sought to bring the cost of borrowing down domestically by raising more short-term funding and internationally by tapping into that large and enthusiastic pool of cheap development and climate finance.

Diversifying the funding sources in that way has enabled the Treasury to avoid the Eurobond market at a time when it would have been unattractive to access it, as director-general Duncan Pieterse notes. That has the added advantage of creating a scarcity that could prompt investors in those Eurobond markets to offer us more attractive rates next time we go there. They are keen to see South Africa's return. With global interest rates and bond yields starting to head down, South Africa will no doubt want to go back at some point.

Borrowing needs will continue to be large in the next few years. The government needs to raise hard currency funding to roll over existing foreign debt as well as to meet other foreign commitments. It is also important to retain a presence in international bond markets to keep South Africa on investors’ radar screens as well as to establish a price or interest rate curve for government debt, which influences the price of private foreign borrowing.

The “risk free” rate on US treasury bonds is the most important driver for the pricing of South Africa's bonds, with the country risk premium added on top of that. In the past two years US treasuries had been trading at their highest levels since before the global financial crisis. The “spread” between South African and US rates had blown out on perceptions of political and fiscal risk. It has narrowed considerably since the election and the formation of the government of national unity.

South Africa still needs to convince investors and ratings agencies that its public finances will stay on track and its economic growth rate will improve. If it does, it could trigger positive action from the ratings agencies that would be a good basis to go back to international markets. That seems unlikely before 2025. The market funding will clearly complement, not replace, continued concessional borrowing.

That raises a more fundamental question about what happens to that money. How much of that developmental financing translates into climate or infrastructure projects on the ground, rather than just helping the sovereign along with its debt management strategy? There is plenty more of that funding available to South Africa. Over and above the funds they have already lent to the government, the international partner countries in the Just Energy Transition Investment Plan have pledged almost $4bn (R70.82bn) more of concessional funding for climate-related projects.

Ideally much of it would go towards the huge investment in South Africa's transmission infrastructure required to bring more renewable energy on to the grid. The constraint is that the pipeline of bankable projects is not yet there. That goes for energy just as it does for infrastructure more broadly. Eskom and municipalities are the key actors that have to produce that pipeline. Also Transnet.

The Treasury can put policies and frameworks in place to enable them to do so and it can guarantee the funding, but South Africa still has work to do to ensure it can make the best use of funding available to it at attractive rates.

Joffe is editor at large.

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