Reserve Bank Governor warns South Africa is heading for serious financial trouble

South Africa’s financial crisis is closely related to the country’s economic stagnation, with the interest rate the state pays on its debt being greater than nominal GDP growth. 

This means that the country will eventually hit a fiscal cliff where the economy cannot sustain the government’s debt burden. 

In the immediate term, it means that government debt crowds out private-sector investment and other state spending priorities, harming economic growth. 

Without much faster economic growth, increasingly difficult decisions will have to be made to limit the state’s spending to service the debt and pay it down. 

Reserve Bank Governor Lesetja Kganaygo said that if the government borrows money to only pay interest on existing debt, the country opens itself up to a debt spiral. 

Kganyago outlined this problem in a recent speech to the National School of Government, which explained the factors influencing South Africa’s monetary policy. 

“I have covered what keeps the short-term policy rate high, but long-term rates are even higher. The 10-year bond yield is just below 10% and the 2048 bond is higher still,” Kganyago said. 

South Africa has a relatively steep yield curve, with investors demanding higher rewards in the form of elevated yields for lending money to the government. 

“You are asking investors to lock in exposure for decades and endure losses if debt does not stabilise and rates rise further. They are willing to bear that risk – but at a high price,” Kganyago said. 

He warned that with nominal GDP growing at about 5% and the government paying around 10% to borrow over the long term, state debt will crowd out private investment and other spending priorities for the country. 

“If we borrow to pay only interest on existing debt, we open ourselves up to a debt spiral,” he warned in the speech. 

Tax revenue will grow more or less in line with nominal economic growth over time, assuming a steady tax-to-GDP ratio. 

This gap between interest rates and growth, sometimes expressed by economists as “r>g”, renders borrowing unsustainable since debt compounds faster than the income needed to service it.

This is at the core of South Africa’s fiscal challenge, as debt-servicing costs are the fastest-growing expenditure item in the budget, with the government spending over R1 billion a day on interest payments.

Growth versus financial stability

Kganyago said it is a mistake to identify South Africa’s debt crisis as primarily a growth problem, with the two being heavily intertwined. 

“Unfortunately, rather than considering the macroeconomic mix, we sometimes get stuck debating consolidation versus growth,” he said. 

“It is sometimes asserted that South Africa does not have a debt problem; it has a growth problem. No doubt, sustained, high growth could solve our debt problem. But it does not follow that the economy is capable of flourishing in the context of fiscal fragility.”

South Africa’s economic growth challenges are closely related to the deterioration of the state’s finances and vice versa. 

“We need to appreciate how our growth problem is endogenous to our fiscal situation. It is negative for growth to have a high and rising tax burden – especially where the quality of spending is low,” Kganyago said. 

“It hurts to have high long-term borrowing costs and a sub-investment grade credit rating. These factors help explain why fiscal multipliers in South Africa are so small. Extra government spending does little or nothing for total output.” 

This shows why growth alone will not solve South Africa’s fiscal problems without an improvement in the state’s financial health. 

“It is also the reason we absolutely cannot attempt an expansionary strategy that aims for growth at the expense of macroeconomic stability, with the justification that growth will itself be stabilising in the end,” Kganyago said.  

“The best thing we could do for growth, on top of structural reforms, is to deal decisively with the country risk premium. It is not growth or stabilisation; it is growth through stabilisation.” 

De-risking the economy would open up space to cut interest rates, boost confidence, and create a more stable environment.

“If we can reduce interest rates through permanently lower inflation, and by de-risking, we can finance debt at lower costs,” Kganyago explained. 

“This would make a big difference. Just to put some indicative numbers on this, for a debt stock of R5 trillion, every percentage point you save in interest is worth R50 billion.”

Reducing this magnitude would free up billions of rands for the state to spend in more productive areas, attract investment through a reduced risk premium, and free up space for more private sector borrowing.