South African debt spiral warning

Citadel chief economist Maarten Ackerman said that, despite GDP growth in the first quarter of 2023, South Africa’s weak currency remains troubling and could see the country fall into a debt spiral. 

Stats SA announced Tuesday that South Africa’s economy grew by 0.4% in the first quarter of this year, surprising experts who predicted the country would enter a recession.

However, Ackerman warned that the country is not on the road to recovery yet and that the rand is of particular concern to future growth.

The rand recently fell to its weakest level against the US dollar and has been stuck trading at above R19/USD since mid-May.

“The country’s current account deficit has seen us pay more in foreign currency to secure our imports, placing the local currency under pressure,” he said. 

“Global liquidity is also drying up as we see cracks developing in larger economies. Only when rates start to normalise, which we expect in the second half of the year, will the dollar come under renewed pressure and possibly boost the rand.”

Until then, the weak rand is having disastrous consequences for the economy. 

The rand’s woes, coupled with the country’s “no-growth environment”, are resulting in the South African Revenue Service being unable to meet its tax collection targets.

The National Treasury reported lower revenue in April 2023 compared to April 2022. Revenue in April 2023 was R85.06 billion, significantly less than the R93.28 billion collected in April 2022.

Finance Minister Enoch Godongwana has also expressed concern about the government’s low revenue in the first quarter of this year. 

According to Ackerman, this low revenue forces the National Treasury to borrow more, increasing the country’s debt-to-GDP ratio and weakening the local currency further.

Signs of this negative cycle could already be seen in the Q1 GDP data. Stats SA reported that the government’s final consumption increased by 1.2%, which will put more pressure on the national budget.

Ackerman also warned of a looming debt spiral for the country in March of this year, saying, “South Africa is in a tight corner, and if we don’t stimulate economic growth, South Africa will come close to another debt spiral.”

In addition, severe geopolitical turmoil also continues to be a cause for concern, as the market is questioning South Africa’s alleged close ties with Russia and China and the potential sanctions the country could face as a result.

Reserve Bank Governor Lesetja Kganyago recently told Parliament that the market is already behaving as though sanctions will be imposed on South Africa.

South Africa’s ties to Russia have already seen foreign investors selling off local bonds and shares. This causes bond prices to fall and yields to rise, increasing the government’s future debt-servicing costs.

The National Treasury has already reported far higher debt servicing costs in 2023 compared to 2022. The government’s debt servicing costs more than doubled in April 2023 compared to April 2022, going from R3.38 billion to R7.80 billion.

‘Negative feedback loop’

Efficient Group chief economist Dawie Roodt has issued similar warnings about the potentially disastrous effect of the weak rand in a high inflation and high interest rate environment.

The South African Reserve Bank (SARB) has been stuck in a hiking cycle since November 2021 in an attempt to control South Africa’s high, sticky inflation.

Their efforts have not borne fruit yet, although there were signs of inflation calming in the April inflation data.

However, this has led to an economic environment where inflation and interest rates are high, but economic growth is low or negative. 

In addition to this environment, the local currency is at its weakest level in decades.

Should the current levels of rand weakness be maintained, Roodt warned that it would create a “negative feedback loop”.

In other words, inflation will rise if the rand remains this weak, and the SARB will have to keep hiking interest rates, weakening the rand further.