South Africa, which is greylisted, faced the risk of financial instability if it courted Russia, which would lead to capital outflows and sanctions, the SA Reserve Bank (SARB) flagged yesterday.
However, the SARB said in its Financial Stability Review, released yesterday that the most notable country-specific vulnerability was the increasingly detrimental and widespread ramifications of an insufficient and unreliable electricity supply, while concerns over the deteriorating South African rail and port infrastructure networks also continued to grow.
The Financial Action Task Force (FATF) greylisting had materialised, with a relatively muted immediate reaction as expectations had largely been priced into financial markets.
The SARB said, however, the longer-term impact remained a vulnerability and would depend on the speed and effectiveness with which South Africa could address the findings that led to the greylisting. The risks were likely to intensify if remedial actions were not implemented in time for the next FATF assessment in 2025.
“A related risk that emerged during the period under review is the possible imposition of secondary sanctions on South Africa which, coupled with the FATF greylisting, could lead to financial instability in South Africa,” it said.
The diplomatic fallout resulting from the comments by the US Ambassador to South Africa on May 11, 2023 led to a sharp sell-off in the South African rand and its worst-ever level against the US dollar, trading at R19.51 to the US dollar on May 12, 2023.
“South Africa’s non-aligned stance in the war between Russia and Ukraine is increasingly being questioned, which may pose a future threat to the participation of South African financial institutions in the global financial system and increases the likelihood of secondary sanctions being imposed on South Africa, the SARB said.
Even in the absence of formal secondary sanctions, counterparts to South African financial institutions could put institutions under intensified scrutiny and decide to reduce their exposure to South Africa as part of their own risk management processes, it warned.
Capital outflows
Meanwhile, the SARB said South Africa had one of the highest ratios of state-owned enterprise (SOE) debt among emerging markets. While Eskom remains the largest contributor to SOE debt, the debt burden of several other SOEs continued to weigh on the fiscus.
The SARB flagged the risk of capital outflows and declining market depth and liquidity.
It said in part, this vulnerability related to the sovereign-bank nexus, as increased holdings of government bonds by domestic financial institutions that largely followed buy-and-hold investment strategies, combined with lower participation by foreign investors, contributed to the declining liquidity in the SA government bond (SAGB) market.
The risks posed by declining market depth and liquidity were further exacerbated by growing fiscal risk, weak demand for new issuances of SAGBs by non-resident investors and South Africa’s idiosyncratic risk factors, such as high levels of load-shedding and the greylisting by the FATF.
The proportion of SAGBs held by local investors increased to 75% in February 2023, compared to 58% in April 2018, it said.
“While deep and diversified markets can act as shock absorbers, price discovery and the ability to raise liquidity in the event of an adverse shock can be severely compromised in undiversified and shallow markets. This could, in turn, trigger further rapid deleveraging, asset value depreciation and collateral calls, which could threaten broader market functioning and, ultimately, financial stability,“ it said.
This was a significant structural shift, especially considering the significant increase in government bonds issued during this period. It raised concerns about the capacity of South African investors to continue absorbing new issuances of SAGBs in future, the SARB said.
National Treasury estimated that the gross loan debt of the South African government would reach a relatively higher peak of 73.6% of gross domestic product in the 2025/26 fiscal year, mainly as a result of the debt relief to Eskom and other SOEs. South Africa’s SOE debt constituted more than 80% of total non-financial corporate (NFC) debt – the highest among its emerging market peers.
The SARB “continues to monitor the high and increasing exposure of the domestic financial sector to government debt, which is regarded as a vulnerability because of the combined impact of South Africa’s sub-investment credit rating, risks to fiscal consolidation, increasing interconnectedness and concentration, and the loss of diversification on the balance sheets of financial institutions,” it said.
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