The Treasury needs to absorb about half of Eskom’s almost R400bn debt pile to sufficiently lower the power utility’s borrowing costs and put it on a more sustainable long-term financial footing, according to Old Mutual Investment Group (OMIG).
Transferring about R200bn of Eskom’s debt to the national government’s balance sheet is likely to widen SA’s overall debt-to-GDP ratio, which is expected to reach 72.8% in the 2022/2023 fiscal year, by between 2 and 2.5 percentage points. That is according to OMIG chief economist Johann Els, who made the estimate at a media briefing on Tuesday at which he also unveiled a series of economic forecasts for 2022.
A widening of SA’s overall debt-to-GDP ratio is likely to cause finance minister Enoch Godongwana to raise the threshold at which he expects the government’s gross debt to stabilise. In his February 2022 budget speech, Godongwana said the Treasury expects its debt levels to peak at 75.1% of GDP by 2024/2025 before gradually tapering off each year until it reached a projected 70.2% in 2029/2030.
“It just seems logical to me that if they really want to make an impact it needs to be around half [of Eskom’s debt],” Els said when asked how much of the utility’s debt the Treasury would need to absorb to meaningfully reduce its borrowing costs.
“The government is already paying R22bn per year to Eskom to help it finance that [debt] ... it needs to be a big chunk.”
Last week the Treasury revealed it was working on a plan to transfer a significant portion of Eskom’s debt to its own balance sheet and had already conducted financial modelling to determine the amount of debt relief required to put Eskom on a sustainable financial footing.
The Treasury has appointed legal counsel to advise it on the implications the plan would have on Eskom’s debt covenants and loan agreements.
Els said while he was unsure whether the Treasury’s plan might involve paying off some of Eskom’s bonds entirely or swapping them for government instruments, he felt the plan is likely to have a positive overall effect on the utility by reducing its cost of financing for future maintenance and expansion.
He did not anticipate a “serious impact” on government bond yields despite the likelihood that the plan would increase the government’s overall debt to GDP.
“Ratings agencies have factored in for the last few years that government will take on a huge chunk [of Eskom debt],” said Els. “It’s likely priced in to a large extent already by ratings agencies ... markets as well.”
Despite Eskom’s debt woes, load-shedding, rising sociopolitical tensions and policy uncertainty, Els was noticeably optimistic about SA’s economic prospects. He expects GDP to expand 2.4% in 2022 and he forecast a rand exchange rate of R15.30/$ by year end.
“We’re not a failed state,” said Els, dismissing the notion as a “strongly outdated” argument. “We’re getting to a point where an individual investor in SA should be overweight SA in terms of his investments.”
Though Els said it would require “massive privatisation” to lift SA’s economic growth rate to between 4% and 5% on a sustained basis, he regards recent energy policy reforms announced by the government as the most consequential structural reform in the country since the transition to democracy in 1994.
These reforms will result in significant private sector investment in power generation, which effectively amounted to what Els called “privatisation by stealth”.
Though Els expects the Reserve Bank to raise interest rates by another 75 basis points (bps) in 2022 — 50bps in September and 25bps in November — he says that will potentially be the end of the current cycle of monetary tightening. Those hikes would take the repo rate to 6.25% by year end, the same level as February 2020 just before the onset of the Covid-19 pandemic, which prompted the Bank to slash borrowing costs to record lows.
“While SA rates will still need to normalise more, there is no need for the [Bank] to be as aggressive as the Fed,” said Els.
Though he expects inflation to accelerate to more than 7% by September or October, he forecast price growth to average 6.5% this year. He also sees inflation moderating to about 5.8% by end-2022, a trend he expects to continue well into 2023 given that SA’s inflation is less severe than global inflation.
“Radical economic transformation is certainly happening in the country, but not the kind that has concerned us to date,” said Els. “Rather, policy is shifting to the right of centre in SA, with increasing emphasis on the private sector’s involvement in the economy, a hugely promising prospect for the future.”
Els also differed from commentators who say SA’s potential greylisting by the Financial Action Task Force, an intergovernmental body that sets standards for combating illicit financial activity, would be worse than a sovereign downgrade. He felt it was likely a fait accompli given the “hoops” SA would have to jump through to avoid the label.
“I feel it would be too optimistic to say we’re not going to be greylisted,” said Els. “I think we’re heading towards a greylisting [but] in terms of the impact ... it’s well signposted ... the impact will not be as severe as a ratings downgrade.”
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