If only South Africa had a pot of gold (or cash under the sofa) that everyone had forgotten about and that was just waiting to be discovered … About half a trillion rand would do it.
Wait. What? There is one?
This is likely to be the incredulous reaction of politicians when they realise the Reserve Bank is the custodian of an esoteric “pot” of cash that stood at an eyewatering, policy-moving R459bn at the end of March. That’s enough to cover the R350 a month social relief of distress grant for 10 years. Put another way, it would cover the country’s funding shortfall this year more than four times over.
That’s no small matter for the ruling party. South Africa is in a fiscal corner, and the only way to beat the R100bn-odd funding shortfall would be to raise more revenue through higher borrowing or taxation, or to cut expenditure in the face of pressing developmental needs. None of them is a palatable option — particularly as the country heads into an election year and the ANC looks to shore up support.
The Gold & Foreign Exchange Contingency Reserve Account (GFECRA) contains the unrealised profits or losses incurred by the Reserve Bank on the country’s foreign exchange reserve holdings that arise purely from changes in the value of the rand against other currencies. Any net profit or loss in the account accrues to the government in terms of section 28 of the South African Reserve Bank Act.
In most countries, central banks pay over some or all of the net profits they earn as a result of these valuation adjustments to their national treasuries once a year.
Strangely, this doesn’t happen in South Africa.
That’s due to a long-standing agreement between the Bank and the National Treasury, which is provided for in the legislation. By implication, it would seem the two institutions would both have to agree before the GFECRA could be unlocked.
Tapping into the stash
The account was all but empty 20 years ago. Now, however, with almost R500bn in the reserve, investors are asking whether there aren’t ways to tap into this to help flatten the yield curve by lessening the need for additional government borrowing.
At the very least, some of the contingency reserve could be used to pay large one-off bond redemptions, they argue. Surely this would be a wise use of the funds, given the high premium attached to additional government borrowing?
Not so, says Rashad Cassim, the Bank’s deputy governor responsible for financial markets. Instead, he stresses that GFECRA balances “are not a windfall that can be enjoyed with no further costs”.
A major constraint on GFECRA drawdowns, he tells the FM, is that these amounts are unrealised gains. In other words, they are paper entries in a ledger whose value can only be realised by selling the underlying asset — in this case, foreign exchange reserves or gold.
This has two implications. First, a portion of the GFECRA balances could quickly be reduced by exchange rate shifts.
It works like this: when the rand depreciates from, say, R17/$ to R19/$, South Africa’s dollar foreign exchange reserves are worth more in rands. This generates an unrealised gain in the GFECRA account. The opposite happens when the rand appreciates.
To provide an indication of the scale of those movements, consider that the balance on the GFECRA grew by R144bn in the year to end-March, reflecting the depreciation of the rand against foreign currencies during this period.
It sounds good on paper. But with the rand having fallen so far, it could appreciate over the medium term if, say, the US Fed starts cutting interest rates next year, load-shedding ends and GDP growth lifts, and/or commodity export prices stabilise and lift, says Sanlam group economist Arthur Kamp. If this happens, the balance on the GFECRA would shrink rapidly.
Another problem, says Cassim, is that distributing GFECRA profits without selling foreign exchange reserves would entail monetisation of the balances, which implies substantial liquidity-management costs for the Bank.
He also denies that the way the funds are dealt with constitutes an anomaly in terms of international practice. Central banks use different approaches when determining how profits should be distributed to governments and how much should be allocated to their contingency reserves, he says.
For instance, many peer central banks draw on valuation effects to offset the cost of carry of foreign exchange reserves, though this has not been the practice in South Africa. Central banks also retain some gains as a buffer against future losses, which would otherwise weaken the central bank’s balance sheet.
In short, says Cassim, “the global practice is not to simply remit valuation gains to governments as profits; they are also employed to finance foreign exchange reserves and to fortify the central bank’s balance sheet”.
The political Pandora’s box
Krutham MD Peter Attard Montalto is dismissive of left-leaning economists at the Institute for Economic Justice and the SACP who seem to think they have found “a new pot of magic money” that could solve all the country’s fiscal problems.
“First, it’s not a pot of cash. It can’t just be tapped like a bank account; it’s a technical balance sheet liability the Reserve Bank has to the Treasury,” he says. It also isn’t owed to the Treasury in the normal sense, as it reflects the “unrealised” gains and losses on underlying foreign reserves that the Bank holds on behalf of the Treasury.
South Africa’s debt situation has also worsened significantly-
“Drawing down these balances would require the sale of forex reserves, yet the IMF [International Monetary Fund] believes South Africa’s reserves are on the low side of adequate, so that isn’t an option,” says Attard Montalto. “And as they are unrealised gains, the account is also volatile in size and so most of it could never be tapped.”
WHAT IT MEANS
There is R459bn in a contingency reserve account at the Reserve Bank, but it isn’t the solution to South Africa’s fiscal challenges
While he concedes that there are other complex operations that could be used to allow the Treasury to call on parts of this liability without selling forex reserves, he fears that these would impose significant costs on the Bank or the Treasury.
But the real reason these balances have never been touched is probably not the technical complications but rather because loosening the purse strings could open a Pandora’s box.
Tapping the GFECRA would raise two big political economy concerns.
The first is that it would send the message to profligate politicians that they no longer need to reduce expenditure to match the economy’s modest capacity to generate revenue.
Politicians may interpret a GFECRA windfall to mean, for instance, that they can keep on bailing out delinquent state-owned enterprises and avoid making the much-needed reforms to ensure they become profit-generating, well-run businesses.
There is also the worry that should the Reserve Bank Act need to be amended to allow for the GFECRA to be tapped it could open the door for politicians to push through other more populist amendments designed to interfere with the Bank’s mandate or undermine its independence. Think nationalisation of the Bank, for example, or making it responsible for broader functions such as promoting employment and economic growth, as the ANC has suggested.
Attard Montalto believes that both the Bank and the Treasury, which have been tentatively studying the issue behind closed doors, will come to the view that the downsides of utilising the GFECRA account far outweigh the upsides.
Krutham attaches zero probability of a GFECRA transfer being announced in the medium-term budget policy statement on November 1, and only a 15% probability of this happening at the budget in February 2024.
Peter Attard Montalto: Pressure could mount, though we see both the Reserve Bank and the National Treasury standing their ground, with reforms happening slowly, only after the elections, if ever.
“We believe there is practically no cognisance of this issue in the political sphere at present,” says Attard Montalto, “[but] if this changes then pressure could mount, though we see both the Reserve Bank and the National Treasury standing their ground, with reforms happening slowly, only after the elections, if ever.”
A call for restraint
If the GFECRA is to be tapped in the long run, economists strongly believe that it should not be used as a temporary plug for large structural gaps in the budget, especially if the government fails to address the country’s fundamental lack of debt sustainability.
“Only a portion of the contingency reserve account would and should be used [and] only for one-off credible spending such as large, expensive debt redemptions,” says Attard Montalto. “And then only if a credible fiscal rule is in place that keeps the underlying fiscus on a sustainable path and in which appropriate coverage of the costs of using the funds is guaranteed.”
Kamp also doesn’t think it’s a good idea to sell foreign exchange reserves to realise GFECRA gains, given that South Africa is a twin-deficit, capital-scarce economy. Foreign capital inflows have waned in recent years and seem likely to remain inadequate in an environment of increasing geopolitical and geo-economic fragmentation, he warns.
“The bottom line,” he says, “is that should we not return to a sustainable fiscal path, funding pressure can be expected to increase over time. The solution is not to scramble around looking for funding mechanisms that offer temporary relief.”
Ultimately, the only way out of this pickle is to address the real problem: the fact that the country’s growth rate is too low and the rate of spending, and the cost of borrowing, too high. Until the government addresses this mismatch, debt will continue to mount, and fanciful solutions will provide only a temporary distraction.
Claire Bisseker
Economics writer
