Government its own worst enemy

The South African government is its own worst enemy when it comes to stimulating investment in the country, as its repeated budget deficits limit the pool of capital available for investments. 

Furthermore, its repeated deficits have resulted in it issuing massive amounts of debt to finance its operations, which has crowded out private companies looking to fund their growth. 

Old Mutual Wealth investment strategist Izak Odendaal flagged these issues in a recent investment note that outlined the potential impact of the new two-pot retirement system. 

Odendaal said most of the attention on the two-pot system has focused on the impact of withdrawals on both retirees and asset managers. 

However, one major benefit has been neglected – the forced savings of two-thirds of retirement contributions. 

“Most of the attention on the new two-pot system has been around the early access to savings for emergencies. But it is the introduction of mandatory preservation that is the game changer,” he said. 

This will force savers to keep the majority of their contributions invested until retirement, growing the capital pool to fund large projects. 

Odendaal explained that domestic savings are a more stable source of funding for fixed investment, which is crucial for sustainable economic growth. 

Thus, growing the pool of savings used to fund investment is key to ensuring sustained economic growth in South Africa. 

Having to raise money in foreign currency to fund investments opens the country up to significant forex risks and makes it highly vulnerable to external shocks. 

The two-pot system’s success in growing South Africa’s savings pool will depend heavily on its combination with other significant reforms. 

In particular, it would have to be combined with fiscal consolidation as the current government deficit almost eliminates any additional savings from companies and households. 

Government borrowing – dissaving – currently consumes a large portion of the domestic savings pool, Odendaal said.  

This ‘crowds out’ private borrowers and raises interest rates, particularly because the market has a dim view of the government’s creditworthiness. 

Despite the recent decline in government bond yields, they remain elevated, increasing the cost of servicing the debt. 

Moreover, the large increase in government debt levels over the past 15 years has not been associated with productive spending, such as large-scale infrastructure upgrades that could facilitate future economic activity.  

This has resulted in the country’s debt-to-GDP ratio ballooning and, thus, its creditworthiness declining to below investment grade. 

The government’s massive debt pile has also ensured that South Africa’s financial system is overly exposed to one entity, increasing the risk of financial instability. 

Earlier this year, the Reserve Bank warned that this would make the local financial sector more vulnerable to external shocks and inhibit economic growth. 

“The domestic financial sector has increasingly absorbed the government’s debt amid the steady decline in non-resident investors’ holdings in recent years,” the Reserve Bank said.

This is not a problem in itself, but the scale at which the government has issued new debt has resulted in the country’s biggest banks being increasingly exposed to a single risk – the government. 

A higher concentration of government bonds on domestic financial institutions’ balance sheets also inhibits the capacity of the domestic financial system to absorb financial shocks. 

It may also lead to increased high volatility and low-liquidity episodes in the domestic bond market, impairing price discovery and deteriorating trading conditions in the rest of the financial market. 

In turn, this would reduce the overall resilience of the domestic financial system.

South Africa’s banking regulator, the Prudential Authority, echoed this warning, saying the financial sector’s exposure to the government has become a “credible concern”. 

“High sovereign debt levels, along with reduced debt and interest servicing capacity, increase the possibility of sovereign restructures or downgrades and defaults,” the regulator said.