South Africa’s R2 trillion risk

South Africa could lose up to R2.2 trillion if its transition to a low-carbon economy is not managed properly, with the process already underway and the country remaining committed to its climate pledges.

Reserve Bank researchers analysed the potential impact of the country’s transition to a low-carbon economy, with its financial sector set to be hit hard in particular. 

Pierre Monnin, Ayanda Sikhosana and Kerschyl Singh found that South Africa’s biggest banks face up to R1 trillion in transition risks. 

This is mainly due to a potential decline in the value of assets used as collateral for loans to companies and individuals. 

Businesses and individuals impacted by the transition might experience significant income reductions, deteriorating credit ratings, and asset devaluation.

This will hinder their capacity to repay debts to financial institutions, causing a rise in defaults. When defaults occur, financial institutions will not be fully reimbursed through the sale of collateral assets, as their values will have declined.

The study found that more than R980 billion in corporate loans from South African banks are tied to companies or individuals whose income and assets are at risk due to the energy transition.

However, the researchers also found that South Africa’s mining sector is threatened by a disorderly transition to a low-carbon economy. 

This has the potential to have a disastrous impact on the entire economy, with tax revenue being affected along with foreign exchange earnings. 

The convergence of a carbon-intensive economy, widespread unemployment and energy insecurity poses challenges for South Africa’s transition.

Between 2013 and 2035, South Africa faces a transition risk estimated at more than $120 billion (R2.2 trillion) in present-value terms. 

This transition risk estimation is largely attributable to coal dependency and a reduced export cash flow of $83.7 billion (R1.5 trillion). 

The risks from a disorderly transition will affect not only South Africa’s potential economic output but also millions of households. 

Data shows that a significant proportion of South African employment comes from high-carbon industries. 

Over 10% of all wage-earners in South Africa work in high-carbon industries, including major economic growth drivers such as mineral processing, oil refining, and cement production. 

Households dependent on industries facing transition risks, such as coal mining, could experience a direct income and employment effect from transition risk through job and income losses. 

A shift in job markets is also an opportunity for job creation: while employment in some sectors will decline, there will be growth in others, such as renewable energy. 

However, transitioning between industries is not straightforward, requiring the development of new skill sets or even geographical relocation.

This also poses a risk to government finances, with a large share of state revenue coming from these sectors through corporate income tax and personal taxes. 

The researchers warned that a disorderly transition and climate change may worsen the government’s existing R5.2 trillion debt burden. 

South Africa’s sovereign risk and financial stability remain intricately tied to the future of Eskom, they said, which is directly exposed to the transition. 

Because of the energy insecurity that started in 2008, markets have so far focused on the energy transition risk and not on all transition risks. 

Aside from a potential decline in revenue, the transition may also result in a sharp increase in expenditure to deal with extreme weather events or provide compensation to workers affected by the transition. 

While some of these effects on the government’s finances may be offset by revenue from a gradually increasing carbon tax revenue, this is unlikely to result in much additional income. 

South African companies, by global standards, are already overtaxed, and the country’s tax base is extremely narrow. Very little can be raised from increasing taxes on companies and personal income tax. 

An increase in taxes may also exacerbate the negative impact of a disorderly transition, discouraging much-needed investment from companies that are vital to absorbing the jobs lost during the transition to a low-carbon economy.