South Africa — Economic woes raise fiscal and external financing stress

South Africa, which has endured long-standing economic and financial problems, has been dealt a severe blow from COVID-19-induced lower global growth and local lockdowns. The IMF predicts a steep 5.8% GDP contraction in 2020, following growth of less than 1% per year on average from 2014 to 2019 (Chart). This will weigh on demand for Australian exports, particularly aluminium and coal; South Africa is Australia’s largest export partner in Africa and 25th highest overall (A$2.1 billion in 2018-19).

Economic deterioration will contribute to worsening fiscal and current account deficits. Financing these deficits will be increasingly challenging and more costly in the wake of the recent sharp sell-off in South African financial assets. The South African rand (ZAR) has been among the hardest hit emerging market currencies in 2020, depreciating to a record-low in April and inflating the value of foreign-currency government debt. Foreign currency government bond yields have also risen sharply, indicating higher borrowing costs.

Rising debt-sustainability risks prompted Moody’s to downgrade South Africa’s sovereign credit rating into sub-investment grade territory in late March — with all three private credit rating agencies now aligned at this lower rating level. This has triggered further capital outflows and depreciation pressure on the ZAR.

Fiscal space is limited to respond to mounting economic challenges, given high and rising government debt (69% of GDP in 2019). Monetary easing also brings risks. Although interest rate cuts could stem the rise in the government’s debt servicing costs, it risks further stoking capital outflows and ZAR depreciation. Potential support from international financial institutions could bring much-needed funding and help shore up investor confidence.