South Africa committing the ‘original sin’

Over the past two years, South Africa has decreased its rand-denominated debt while increasing its foreign currency-denominated debt, committing the so-called ‘original sin’ of emerging markets.

The Bureau for Economic Research (BER) explained that the ‘original sin’ refers to the inability of many emerging markets to borrow in their own currency on international markets.

This forces emerging markets to take on foreign debt in stronger currencies like the US dollar, which increases their vulnerability to exchange rate risks.

This has not always been the case for South Africa. Between 2004 and 2019, the country’s foreign debt as a share of GDP rose sharply. However, the share of South Africa’s rand-denominated debt also increased from around 30% to 60%.

“South Africa could borrow in rands, avoiding the constraints of the ‘original sin’ and ‘fear of floating’ faced by many emerging markets,” the BER said. 

“However, the past two years have seen a decrease in rand-denominated debt and an increase in foreign currency-denominated debt.”

Having more foreign currency debt than rand debt poses a significant threat to South Africa’s financial stability.

Firstly, if the rand weakens against the US dollar or other foreign currencies, South Africa’s debt repayments become more expensive in rand terms.

This means the government needs to spend more on repaying debt, leaving less money for essential services like infrastructure, healthcare, and education.

This is a significant problem for a country that already spends more than R1 billion a day in debt-servicing costs.

The graph below, courtesy of the BER, shows how South Africa’s reliance on foreign debt to fund its expenditure has grown.

Finance Minister Enoch Godongwana revealed in the 2024 Budget Speech that the government will spend R382.2 billion on debt-servicing costs over the 2024/25 financial year.

This makes debt servicing costs the third-largest expenditure item in the country’s Budget, outpacing expenditures on policing and social grants. 

Having a large part of this debt be foreign currency-denominated also gives the government less control.

This is because, when borrowing in rand, the government can manage its debt by influencing interest rates or printing more money.

If needed, South Africa can also restructure rand debt without needing foreign approval.

In addition, interest payments on this debt stay within the country, supporting local financial institutions rather than flowing abroad.

However, with foreign debt, South Africa has no control over global interest or exchange rates, making it vulnerable to external shocks.

Foreign debt repayments could become unsustainable if the country faces an economic crisis and the rand crashes.

This increases the risk of default, leading to lower credit ratings and higher borrowing costs in the future—things South Africa cannot afford.

In addition to these risks, South Africa’s heavy reliance on foreign currency debt signals that local investors are not confident in the economy.

If international investors lose confidence, they may stop lending or demand higher interest rates, worsening the debt burden.

This has already started happening. The BER pointed out that growth in the purchase of South African bonds by foreign investors has slowed.

This is due to, among other factors, uncertainty about the local political environment and South Africa’s greylisting in 2023. 

As a result, the share of South African government debt held by non-residents has declined from about 40% to 25% over the past few years. 

This can be seen in the graph below, courtesy of the BER.

The BER said the local asset management industry has taken on most of this new government debt.

“With de-listings on the JSE and fewer investment options due to weak economic growth, asset managers have increasingly turned to government bonds,” the organisation said.

Another risk posed by foreign currency-denominated debt constituting the largest part of government debt is the ‘original sin’ problem.

While taking on foreign debt may be easier for some emerging markets, this makes them dependent on foreign lenders and vulnerable to global financial conditions, limiting their economic independence.

The BER also pointed out that South Africa’s foreign assets have outweighed foreign liabilities since 2015. 

In other words, since 2015, South Africans have invested more money abroad than foreign investors have put into South Africa.

The BER said this was caused by an outflow of investment, with slow economic growth and policy uncertainty as contributing factors. 

“For the same reasons, foreign liabilities – i.e. investment by foreigners in South Africa – have stagnated,” it said.

Looking forward, the BER explained that policy stability and fiscal discipline will boost confidence in South Africa, leading to an inflow of capital reflected in a stronger financial account.

“Reforms that support export growth will help to keep the current account deficit in check,” it said.

“Combined, these factors will help grow South Africa’s foreign reserves and repay its debts, creating fiscal space for other priorities.”