The South African government has announced it will use the South African Reserve Bank's (SARB's) paper profits in a bid to partly tackle the country's government debt levels. On Feb. 21, the National Treasury's 2024 budget outlined plans to draw on the country's gold and foreign exchange contingency reserve account (GFECRA) at the SARB amid slowing revenue growth.

The GFECRA holds unrealized gains from currency fluctuations and gold price shifts. A depreciation of the South African rand (ZAR) increases the value of the foreign currency holdings relative to local currency. The GFECRA's balance has risen to about ZAR507.3 billion (about $26.6 billion or equivalent to 7.0% of GDP), in January 2024 from ZAR1.8 billion (0.1% of GDP) in March 2006. At the same time, the country's gross general government debt has increased to an estimated 75% of GDP in fiscal 2023 from less than 30% in 2001 given subdued economic activity and ongoing fiscal deficits averaging 3.6% of GDP over this period. Meanwhile, interest costs almost doubled to 18.5% of revenue last year, placing an increasing burden on public finances.

The role of central banks has increasingly narrowed to ensure price stability, so they are not necessarily profit seeking, even if they often post profits and losses. During the era of quantitative easing, most global central banks were paying dividends to their government shareholders on the back of positive net interest margins. Although the practice of using unrealized valuation gains on foreign exchange is not unusual among developed and emerging economies (for example, Switzerland, Brazil, Chile, Hungary, and Kenya), it is relatively uncommon globally and could expose the country to risks on the monetary front.

Here, S&P Global Ratings answers questions from investors on how it might view South Africa's fiscal and monetary positions in light of this development.

Frequently Asked Questions

What are the fiscal benefits for South Africa from the plan to draw on the GFECRA?

This plan is a convenient, but limited and temporary solution to the country's long-standing fiscal challenges, in our view. These issues include wage pressure, social spending, and support for state-owned enterprises. The government is planning to use ZAR150 billion (2% of GDP) from the GFECRA over fiscal years 2024-2026. It also intends to formalize a framework between the National Treasury and SARB to use the GFECRA to reduce government borrowing beyond these amounts. The practice of tapping into the GFECRA could encourage moral hazard or lead to increases in spending that might be hard to reduce. However, authorities have clarified that these gains will not be counted as government revenue but recorded "below the line" as fiscal financing, therefore not affecting fiscal deficits.

There are three key upsides: 

• A 1.8% reduction of central government debt by fiscal 2026, according to official figures. Our debt forecasts are higher than the government's because we incorporate some slippage on spending.
• A decline in debt-servicing costs by $1.6 billion, or 0.4% of GDP, over the next three years. This would reduce the general government's interest-to-revenue ratio to 19% on average over fiscal years 2024-2026 from 19.5% in our previous forecasts.
• Some relief on domestic capital markets due to relatively fewer domestic debt issuances. Despite having strong capital markets, fewer issuances would help reduce yields and free up capital for private sector lending. Banks' exposure to the sovereign rose to 15% of total assets in 2023, from less than 10% in 2015.

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What are the implications for South Africa's monetary framework?

Transferring unrealized profits to the government and the economy poses risks to the monetary transmission mechanism and increases the potential for politicization of the SARB. However, the government and the SARB will likely aim to mitigate these outcomes by implementing a rule–based, transparent framework. This would include the sterilization of funds to control inflation, ensuring provisions for the SARB to maintain sufficient capital adequacy to conduct monetary policy; and imposing restrictions on ad-hoc government access to the GFECRA account for fiscal purposes.

The key risks are:  

• Higher inflation. The monetary expansion resulting from the transfer of unrealized profits could add inflationary pressures. The SARB aims to reduce inflation to the mid-range of its 3.0%-6.0% target. Inflation stood at 5.3% in January 2024, down slightly from a 6.0% average in 2023. Authorities aim to address this by only buying back government debt--but this could be counterproductive if it turns into an expansionary fiscal position and if the SARB comes under recurrent pressure to finance higher budgetary requirements (which is not our baseline expectation). The inability to ensure price stability quickly erodes the credibility of monetary authorities, often leading to unintended and negative consequences, including capital outflows, exchange rate devaluations, and runaway inflation.
• Unrealized gains that could turn to losses if the rand appreciated, leaving the SARB with negative equity. If the central bank gets into a negative equity position and solvency is in question, the government may need to recapitalize the central bank, with potential implications for public finances. The planned final framework will include provisions for the SARB to maintain adequate buffers to absorb exchange rate swings, though it is unclear how this will be calculated. In addition, ZAR100 billion will be transferred from the GFECRA to the contingency reserve at the SARB to partly absorb sterilization costs to neutralize any interest rate influence. That said, central banks can theoretically operate with negative capital for a time without losing credibility.
• Loss (or perception of loss) of SARB independence. Granting government access to unrealized profits could politicize the SARB and prioritize fiscal needs over broader monetary and economic stability. We view the SARB as an independent and credible institution with a track record of maintaining low inflation and competently regulating the financial system.

How do the monetary and fiscal policies intersect?

Monetary policy inevitably affects fiscal policy by influencing the cost of debt and through profit sharing. The situation becomes more challenging when monetary operations involving net lending to sovereigns end up undermining price stability. This often occurs in economies with limited domestic savings, shallow capital markets, high import dependency (and considerable potential imported inflation), and partially dollarized financial sectors.

On the face of it, South Africa suffers from none of these problems. Given some of the deepest local currency capital markets among emerging markets, and minimal foreign currency lending in the private sector, the South African government benefits from considerable domestic financing options. These characteristics--which include a strong external profile--have underpinned our sovereign rating on South Africa for decades. Nevertheless, the steady increase in South African government debt, and the rising cost of servicing it, have created a strong incentive for the government to find ways to reduce fiscal pressures.

Related Research

• South Africa 'BB-/B' Foreign Currency And 'BB/B' Local Currency Ratings Affirmed; Outlook Stable, Nov. 17, 2023