South Africa’s financial stability is at risk from the government’s debt and interest payments growth, as the country’s financial sector has increased its exposure to local government bonds.
The Reserve Bank issued this warning in its latest Financial Stability Report (FSR), released this week.
The report noted that the government’s debt burden has continued to grow, reaching 72.7% of GDP in the second quarter of 2023. This is well above the emerging markets average of 50%.
South Africa has continued to spend more money than the government can collect in tax revenue, resulting in consistent budget deficits, which have been plugged by borrowing more.
However, the Reserve Bank is more concerned that the government’s debt servicing costs have more than doubled since 2008, crowding out other expenditures and raising the prospect of a debt spiral.
The share of debt-service costs to the main budget revenue increased markedly from 14.3% in 2019 to 20.7% in 2023, well above its long-term average of 13.0%.
The government projects that its debt-service costs will settle at 22.1% of main budget revenue in 2026 and 5.4% of GDP before easing.
This has resulted in the South African government paying a greater premium on its debt to encourage investors to lend it money – further increasing its debt servicing costs.
South Africa’s 10-year bond yield has surged by 390 basis points since 2018, while the yield curve has steepened significantly.
This steepening of the yield curve reflects heightened fiscal risk, a primary factor driving up sovereign yields.
The proportion of South African government bonds held by foreigners has declined significantly over the past five years.
In 2018, foreigners owned 38.7% of SA bonds but this has since dropped to 25.4%. This represents a substantial decrease from the previous decade when foreigners typically held closer to 40% of local bonds.
Over the past decade, domestic banks and financial institutions have taken on a greater role in supporting the South African economy, filling the void left by foreign investors who have been reducing their holdings of local bonds and shares.
This shift in investor behaviour poses potential risks if the country encounters domestic or external economic shocks.
Thus, the growing burden of government debt has been accompanied by a parallel rise in the exposure of the domestic financial sector to this debt.
This raises the spectre of a vicious feedback loop between the sovereign and the financial sector.
“The escalating concentration of government-owned banks in the hands of domestic investors, coupled with the elevated levels of government debt, poses a significant threat to the stability of the financial sector,” the report said.