One thing the ANC did not break

South Africa has managed to avoid raising a significant amount of debt in foreign currency due to the country’s well-developed financial markets and relatively deep capital pool. 

In this way, the country has dodged a bullet that has caused the collapse of many emerging market economies and fellow African states. 

Typically, these countries cannot raise debt in their own currency as they have shallow capital markets and an unsophisticated local financial system. 

Raising debt in foreign currency exposes a country to significant risk, such as foreign exchange rate fluctuations, which often result in the debt burden becoming unsustainable. 

Efficient Group chief economist Dawie Roodt said South Africa has managed to avoid this potential disaster because of its well-developed and regulated financial system. 

Roodt explained that this is mainly due to the work done by the Reserve Bank and the National Treasury in maintaining South Africa’s financial stability. 

Around 13% of South Africa’s government debt is held in foreign currencies, with much of it being in US dollars, euros, or with the International Monetary Fund (IMF). 

This is extremely low compared to many other African countries and emerging markets, which do not have the luxury of raising debt in their own currency. 

Roodt explained that having a significant debt burden in foreign currencies poses a major risk to a country’s stability as the debt is denominated in the currency of the lender and not the borrower. 

This means that if the currency in the borrowing country weakens or the lender’s currency strengthens, it becomes significantly harder to service that debt. 

Foreign exchange fluctuations often exacerbate a commodity-price collapse or an economic slowdown. This combination typically results in a debt crisis and an economic collapse. 

However, South Africa has, so far, managed to avoid any risk of this as the country has the luxury of raising debt in its own currency due to its sophisticated financial system.

“The foreign exchange reserves held by the Reserve Bank are more than sufficient to pay off South Africa’s foreign debt,” Roodt told the State of the Nation podcast. 

“The one thing the ANC did not break was the local financial system by going on a borrowing binge overseas and raising debt in foreign currencies.” 

“The reason why they did not raise too much money abroad was that we have this well-developed financial system and markets in South Africa. It was relatively easy for them to borrow money in South Africa.” 

South Africa’s real debt problem 

The government’s ability to borrow money locally means that South Africa does not have a foreign debt problem and is unlikely to be plunged into a debt crisis by a rapidly weakening local currency. 

For Roodt, the real problem is the increasing burden on local financial institutions and investors, who have had to increasingly take on the government’s newly issued debt. 

Foreign investors have significantly reduced their exposure to South Africa over the past decade, amidst political turmoil, a rising debt load, and as the country was moved into sub-investment grade, or junk status, by credit rating agencies. 

This has left local banks, insurers, pension funds, and investors to pick up the slack with regard to government debt, increasingly exposing the domestic financial sector to a common entity and risk – the government. 

“Foreign debt is not our problem. People say we are running to the IMF for loans, and we do borrow some money from them, but that is not the issue,” Roodt said. 

“The IMF has only been used to assist countries that run out of dollars, and that is not our problem in South Africa. Our problem really is that we have too much rand-denominated debt that is crowding out private-sector borrowing.” 

The Reserve Bank has repeatedly warned that local banks and institutions are increasingly exposed to government debt, risking South Africa’s financial stability. 

The bank has warned in several Financial Stability Reviews that South Africa’s financial system is at risk of becoming overly exposed to a single common risk in 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 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.