South Africa’s survival and recovery options
Guest lecturer in corporate and development finance at USB, Jason Hamilton, says South Africa needs a long-term growth plan after lockdown ends.
The full impact of the pandemic and the health-related counter measures taken is starting to come through in the economic and financial forecasts. We have seen the South African Reserve Bank (SARB) in short succession review its outlook of the 2020 Gross Domestic Product (GDP) growth from 0.2% retractions (in March) to a 6.1% retraction at the last Monetary Policy Committee (MPC) rate announcement in April, which confirms how sharp and severe the impact has been on the economy.
South Africa is still in the beginning stages of the fight against the pandemic, with the view that SA’s infection rate will peak in September, although it seems as if positive impact has been gained when considering the flattening of the new infections curve. It is too early to accurately forecast how the coming months will play out which in turn, being directly correlated to any estimate of a recovery, makes predicting the full economic impact and recovery very difficult.
What has become clear is we will likely not see a sharp and quick economic bounce back many has been hoping for but will in all likelihood see a 12 to 24-month gradual recovery, once the pandemic is under control.
This is based on a few assumptions but mostly driven by the fact that the economy will take time to gain traction once the lockdown has been lifted as any form of claw back will be directly linked to a global recovery and ability to trade.
The ability to recover and its pace will also be directly linked to the ability of our trading partners to recover, this will add to the complexity to any recovery phase and also impact the timeline directly.
We also base the timeline of recovery on the assumption that the pandemic will be under control within the next few months, something that can only be certain once a vaccine is found and rolled out at scale, which could be 24 months away. In addition, the risk of a flare up remains high and we have seen this risk highlighted in China with increasing numbers of new cases.
Any narrative related to recovery and growth should be seen in context of what returning to ‘normal’ means and if this is even possible. Globally we have seen a slow down over the last few years with most developed economies’ GDP growth coming under pressure (can refer slowdown in China and very low growth in Germany and other EU countries), hence returning to normal will see us returning to a world that’s under pressure and possibly not able to sustain the levels seen historically.
In South Africa this is a slightly easier debate (and to understand) as our economy was under pressure for years prior to the pandemic and will remain so for the foreseeable future. The SA deficit which will be revised upward shortly was projected at 6.8% of GDP (R370bn) and this will breach the 10% mark to settle at some point between 10% – 12%, although we could see 14% being tested, resulting in a R544bn to R652bn deficit or at the upper end up R760bn which must be addressed in the revised budget and recovery plan.
What has become clear is we will likely not see a sharp and quick economic bounce back many has been hoping for.
We are predominantly dealing with a health crisis and all actions taken to date has been to limit the loss of human life, this is also clear with the updated stimulus package with significant allocations made to health and health response rated expenses. However, the impact of the pandemic is financial and could easily lead to a financial or economic crisis if not managed correctly through the short/medium term action taken and through the deployment of a carefully crafted long term recovery plan.
It is imperative that government and private sector remain focused on the immediate response and support required, hence spending on healthcare and protecting employment (and by default limiting as many bankruptcies during the process), we have seen further social stimulus provided to assist the vulnerable and unemployed through further grand allocations made. We will, however, require a strategic forward-looking view to be taken to ensure an integrated recovery plan is crafted.
We have seen elements of this coming through already if we look at the action taken by the MPC: It has reduced the repo rate by 225 basis points this year already. This will reduce debt costs and provide some reprieve but the full effect of rate changes take between 6 to 12 months to fully filter through the economy, which mean this action is also being done with a forward looking view and recovery in mind.
Given that South Africa has limited fiscal headroom there still remains a few viable options and strategies that can be explored in conjunction with the private sector to not only assist with the health crisis and bridging requirements, but also to be deployed in preparation and during the recovery phase.
The liquidity of emerging markets is under further pressure with foreign direct investment (FDI) being withdrawn and moving to what is perceived as safer assets and currencies. Since the beginning of the year over $100bn has been withdrawn.
Many nations are also reliant on remittance flows to fill the gap. In some cases this is significant, ranging between 10% to 20% of GDP. This will also reduce and could remain low for some time.
Both these implications can be addressed by increasing the special draw rights (‘SDS’) to assist nations with foreign currency that was lost due to FDI and the lower remittance levels seen. South Africa is a very well traded market albeit speculative and should be able to manage its foreign currency reserves through the cycle and is not reliant on remittance flows.
The impact of the pandemic is financial and could easily lead to a financial or economic crisis if not managed correctly.
In the emerging markets on average over 20% of budgets are used to service debt, In South Africa this is around 12%. Restructuring current debt terms and condition can assist in freeing up significant cash flows and provide much needed headroom over the coming 24 months. This can be done by freezing interest and/or placing a general moratorium on debt payments, either under current facility/bond terms or through a formal restructuring approach.
Development banks will need to look to increase lending and hence its allocation received to enable further funding to be provided. This could take the form of loans and even grants. Any additional funding provided now will need to be aligned to the crisis duration. Those provided for growth must be aligned to the underlying projects. As such, we should see increased tenors coming through to provide for longer lead times.
A significant portion of latest stimulus package of R500bn announced on the 21st of April will be sourced from global partners, the IMF, African Development Bank and Brics Bank, although the detail of this has not been announced as yet.
Development Finance Institutions
DFI’s are well placed to assist now and during the recovery as they are already invested and have direct local access in many cases. They further have local knowledge and a proven track records. They are best placed to assist current clients with support and new debt facilities, however they will need to relax credit and return criteria to increase the investment scope. They will also be required to provide funding likely linked to the profits of the company or project to provide the scope for the company to recover.
They will also have to consider providing debt moratoriums on current and new investments made to assist with the short- and medium-term liquidity requirements, again this can be done under current facility terms or through a formal restructure request.
In conjunction with co-investors on the private and public sectors (asset managers, government, PE firms, etc.) DFI’s can be accessed to fund recovery and growth projects, specifically health, manufacturing and infrastructure programmes. It is likely to be achieved by way of a convertible note point where additional risk is being taken.
Companies with strong ESG (environmental, social, governance) principles or alignment to the sustainable development goals (SDG) will be best placed to secure new investments and funding (Impact Investment) during the recovery as they will not only offer financial returns but also long-term sustainability.
Commercial Banks and Private Sector
Similar to DFIs, commercial banks and other financial services providers have well established processes and distribution systems in place with direct links to companies and individuals which enable them to assist in providing access to short term liquidity and bridging. This assistance will however still be provided on commercial assessment and risk terms, although we have seen regulations being adjusted (capital adequacy and liquidity ratios) to allow banks further headroom to increase its lending scope. Further movement here can be taken although care should be taken to not overextend in terms of risk and long-term viability.
Commercial banks can be used to provide further liquidity into the market over the short to medium terms and is best placed to also provide debt to firms during the recovery phase. However, if low or no interest rate borrowings is required or lending that is too far from the adjusted risk return profile, then external guarantees will be required, which has now been announced with a R200bn allocation made to be made by government, initially this will focus on firms with turnover less than R300m. We can refer to the 2008 financial crisis to see what the implication can be if banks provide facilities to risky clients and hence if they are required to move beyond the regulated framework the support will need to be provided.
We will, however, require a strategic forward-looking view to be taken to ensure an integrated recovery plan is crafted.
Private debt held by institutional, local and foreign investors is a key funder and provider of liquidity for South African corporates. Companies can access liquidity here as well, if they are able to negotiate three to six months debt payment moratoriums. However, this has proven difficult if we look at what has happened in the US and EU private debt markets. Companies should however review their agreements to see what options are available to them. Governments have already provided opinion and guidance to the sector to motivate aligned action. We will likely see a step up in these actions if the market isn’t accommodating.
Restoring confidence is one of the major factors needed to attract FDI. Specifically to fund a 3 to 5-year recovery drive. Despite investors seeking safer assets they are also still hunting for yield. Prior to the crisis, Emerging Markets and Africa provided great prospects. This appetite still remains, but to sustainability attract long term FDI governments will need to have a clear plan and act decisively in execution.
The budget was announced in February 2020 and will be reviewed. We will see funds being reallocated; we will also see further cost cutting taking place to free up needed headroom to ensure a focus on efficiency. In the latest announcement R130bn will be freed up through reallocations and details will be provided in the revised budget.
We could also see the selling of non-core assets being progressed as this option was noted during earlier announcements (including the revenue from selling broad bank spectrum).
The UIF and Government Employees Pension Funds have significant surplus funds available that could be accessed. There is also an under allocation across some of the mandated investments leaving headroom for allocation of additional funds which can be deployed as directly or co-investment. This can be a viable source of capital to assist during the rebuild and recovery phase. Access to the UIF funding reserves has been noted in the updated stimulus package as part of the R500bn package.
Private sector savings can be accessed directly or through the asset managers with regulatory adjustments (adjustment t prudential limits), which will increase the funds available for local deployment. This will require the review of return profiles and investment criteria to ensure alignment. As with DFIs, increased investment will be aligned to ESG/SDG projects and companies. This will require careful considerations as the funds have obligations to its beneficiaries which in most cases are the most vulnerable in our society, such as pensioners. But its technically is a viable funding source.
We will also see a renewed focus on the already established regional trade zones which can effectively be used to leverage trade and enhance relations. What is required is a unified approach, both during the crisis and for any recovery plan.
The African Continental Free Trade Area is an agreement that unifies the African continent and its 1.3 billion people which, if managed correctly, can put Africa in a very strong position by forming a unified trading bloc and creating a regional value chain. This could be the secret sauce that the content has been looking for and execution over the next 5 years is going to be crucial.
Stimulus could also be provided through reducing the tax burden on the private sector, ensuring more funding is available for reinvestment and investment. This can be done by reducing VAT and reducing company tax rates. However, this can likely be achieved through other incentives to drive right behaviour. What we have seen announced is the deferment of VAT, PAYE, Tax and other levies to assist and these have now been revised to provide further assistance.
South Africa is Africa’s most industrialised nation with a very sophisticated financial system, which provides it with a few options to consider and even the private markets that can be successfully accessed by government and local companies.
All the ratings agencies have SA at sub-investment grade, however this now provides the platform to rebuild and design plans to support a growth programme without having to worry about downgrade risk. A very slim but silver lining.
The pandemic has also proven that we are a global economy and reliant on each and every market for our own success. This unity and joint action will be the crucial factor that will determine our successful rise and recovery.
Jason Hamilton is director at First River Capital. He has over 15 years of experience in the banking and the financial services sector where he focused on corporate finance, project finance, leveraged and acquisition finance. He is Guest Lecturer on USB’s Development Finance Programme, present on Capital Raising for Public and Private Projects. He is also Guest Lecturer on USB’s MBA programme, present on Corporate Finance, Mergers & Acquisitions and Funding Strategies. He serves as Faculty at USB Executive Development, and Facilitator for USB’s International Affairs programme. He has been appointed to the Thought Leadership and Business Ethics Committee of AICPA (The Association of International Certified Professional Accountants) | CIMA (Chartered Institute of Management Accountants) effective 1 June 2020.