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The great trek back to market

Want to invest in repackaged loans for low-cost black housing? Or the City of Johannesburg? South African telecommunications? The lifting of sanctions on South Africa could unleash a pent-up demand for funds totalling $3 billion to $4 billion a year or more.


Planeloads of bankers and investors are arriving in the country although, as locals admit, they tend to carry notebooks rather than chequebooks. With a Eurobond issue for the republic in the works, the outlook appears promising. But those fat margins are caused by concern over political risk and represent a real fear that the nightmares may come true. Garry Evans assesses the problems and prospects as South Africa re-enters the world economy.

South Africa is back in the international capital markets. From 1986 to 1989 South African companies and banks were almost totally excluded except for minimal amounts of trade finance and foreign exchange lines. But in the last 12 months the money has begun to flow again. Last year the country attracted new international funds of just over $1 billion. Preliminary figures for the first half of 1991 suggest a net inflow of capital for the first time since 1985. Already this year, seven privately-placed bond issues in the Euromarket have raised $330 million. Lenders are lining up to take part in project and aircraft finance deals. South African banks report that their short-term credit lines from foreign banks have doubled and that longer-term money is now available.

For foreign banks and investors, the resurrection of South Africa will present inviting business opportunities. This is particularly so because the extra risks involved in lending to South Africa bring not only high margins (the recent private placement by the republic came at 280 basis points over US treasuries) but also the chance for investment bankers to come up with innovative structures. One South African merchant bank, for example, is developing collateralised housing loans for low-cost black housing that attract investors on ethical grounds, offer a high yield but, being backed by South African government bonds, are relatively safe investments.

The volume of business is potentially large too. In 1984, the last full year in which South Africa was able to tap the Euromarket, it raised $1,072 million in public and private bond issues. Add to that another $457 million in syndicated loans, and its gross debt inflow that year amounted to 2.5% of gross domestic product (GDP). In 1976 capital raised in international markets reached 3.8% of GDP. If that level of borrowing were achieved again, South Africa could be looking for $3 billion to $4 billion a year. Given the need to develop long-ignored parts of the country's infrastructure as blacks take a larger role in government, and given that, by international standards, South Africa's debt is small (foreign debt as a percentage of exports of goods and services was 70% at the end of 1990 compared with an average of 255% for developing countries in the western hemisphere), the figure could be very much higher.


If the opportunities are potentially great, so are the risks. That is the reason for the fat margins. Not the least of the threats is the political risk associated with the change-over to a new government, the· structure of which cannot be predicted. The consensus among informed observers in South Africa is that the most likely outcome of the political negotiations will be, by 1993 or 1994, some form of coalition between the white parties and the African National Congress (ANC), with constitutional safeguards for whites.

But a number of nightmare scenarios are almost as likely. These range from a breakdown of negotiations ending in civil war, to an ANC-led government that, despite its present policy declarations, is forced by popular pressure to nationalise and confiscate wealth on a massive scale.

But the banker who told Euromoney with surprising frankness that "the only risk in South Africa is black risk" was not quite right either. Commonplace banking risks abound too. Inflation remains stubbornly high and the economy shows little sign of a strong recovery from the recession (see box). Lack of access to International Monetary Fund facilities and low foreign reserves have left the country's balance of payments vulnerable. And although the rand exchange rate and interest rates have been stable recently, they have experienced worrying levels of volatility in the past.

But if things do go right, the landmark deal to crown the return of South Africa to respectability will be the first public Eurobond since April 1985 by the republic itself. Before the Inkatha scandal (in which the government admitted it had financed Chief Buthelezi's Inkatha movement) in July, bankers close to South Africa suggested that such a deal would be brought this month. Rumours suggest that Deutsche Bank won the mandate, probably for a Deutschmark issue, beating Union Bank of Switzerland. A spokesman for Deutsche would not confirm this, saying only that it was "too early to think about an issue for South Africa". He admitted, however, that the bank planned to hold an investor presentation for the South African government in Frankfurt at the end of August.

Gerhard Croeser, director-general of the Department of Finance (DoF) in Pretoria, admits that "the precise timing is difficult". Originally, he says, the idea was to "reaccess the market in October or thereabouts. [But] I'm not sure whether that's an ideal time or not. We are [now] talking about the end of the year or the beginning of next year".

While the republic's deal will be the first public issue, there has been a flurry of private placements since the market reopened in 1988. Until this year, these issues were all small, in Deutschmarks or Swiss francs, aimed at retail investors, and represented refinancings of maturing debt rather than new money. Membership of the syndicates was undisclosed for political reasons and, in the usually leaky Euromarket, details of lead and co-managers have remained secret. It is believed that the big three German and big three Swiss banks have all been involved; BHF-Bank and Chartered WestLB are names also mentioned.

From the beginning of this year, however, the market has become considerably more accessible and issues more frequent. Data collected by the Centre for the Study of the South African Economy and International Finance at the London School of Economics, the definitive source for such information, indicates that several firsts (firsts since 1985, that is) have been achieved. In March, the electricity supply monopoly, Eskom, brought the first four-year issue; previous issues have been for three years or less. The republic reopened the dollar market in April, and was followed in April by Eskom with a five-year dollar issue – the first in that currency to represent new money, not the refinancing of a maturing bond. In July, AECI, a chemicals company 30%-owned by ICI, became the first private-sector issuer.

This rebirth of the market has been closely stage-managed by the South African DoF. It has enforced an informal queueing system and held its borrowers back from doing a public issue until it felt the market was ready. It has also tried to restrict the amounts raised to about 50% of the retiring debt. Says Croeser: "We deliberately tried to restrict our demands on the market. We could have done more, but that would have put pressure on rates. I think we will progressively get better access. [It will be] easier for the banks now because sanctions are off."

By all accounts, the borrowers could have raised more if they had tried. For its April issue, which refinanced a maturing $75 million Eurobond, the republic had planned to do only $20 million-$25 million. Its banks persuaded it to issue $50 million. Comments Croeser: "The market was more buoyant that we initially thought." He, and other borrowers, say that offers of new issues arrive almost daily from investment bankers. "We have many bankers breathing down our necks to get us into the market because it would give them a competitive advantage," says Croeser not unhappily.

Secretive nature

The secretive nature of the private placements does not make life easy for the issue managers. One London-based bank that co-managed the republic's dollar issue says that some offerings have been so private that the managers do not know the composition of the syndicate and sometimes not even the total amount of the issue, only their own allocation.

Over the last year foreign retail interest has not been restricted to South African international offerings. A flood of money has poured into domestic rand-denominated bonds, both gilts (South African government paper) and semi-gilts (issues by the para-statals such as Eskom). Eskom carries out an annual survey of its foreign bondholders, a complicated task since most hide behind nominee accounts. Last year's survey found that 44% of its stock was held by foreigners (double the previous year). Willem Kok, Eskom's treasury manager, thinks the figure this year could be as high as 50%. Some of that 50% – perhaps as much as a half, sources suggest – comprises non-resident South Africans. By contrast, South African institutional investors' share has fallen from 60% in the late 1970s to about 30%.

The foreign interest has helped to keep down Eskom's cost of funds. Its benchmark E168 issue trades at a yield about 40 to 50 basis points lower than comparable government stock. It is almost unknown elsewhere for the paper of a state-owned corporation to yield less than government paper. Eskom's commitment to make markets in its own bonds and its writing and sale of options on them has undoubtedly helped the liquidity of its issues.

The attraction of South African fixed income products to foreign investors is explained mainly by the advantages of the financial rand mechanism. Foreigners buy and sell securities (and some other assets, such as commercial real estate) with the financial rand, which was introduced at the time of the 1985 debt crisis to protect the country's foreign exchange reserves. It trades at a – sometimes considerable – discount to the commercial rand (see graph). Coupon and dividend payments, however, are in commercial rand, which enhances the yield to the foreign investor. High interest rates (government stock has yielded about 16% for the last two years) and, until the end of last year, a substantial discount on the finrand gave foreign investors real returns of 27% in 1990, according to Chartered WestLB. That return has been additionally enhanced by the considerable narrowing of the finrand discount. It fell to as low as 6% in the middle of July after the US government announced the lifting of trade sanctions on South Africa; put another way, the rate of the finrand against the dollar has risen from 4.2 in mid-1989 to just over 3. The German and Swiss retail investors who began buying these bonds two years ago have made a tidy packet.

Perhaps too late, institutional investors are now reportedly becoming interested. Says Michael Andrew, an assistant director at Chartered WestLB, which makes markets in gilts and semi-gilts in London: "This is still mainly a retail phenomenon. But more and more serious fund managers have been asking about the advantages. We have seen some buying, and interest even from North America."


Adds Leon Kirkinis, assistant general manager of project services at UAL Merchant Bank in Johannesburg: "The really smart money has been here, the risk takers. But people who invested in South Africa in 1986 and 1987 lost money, so the bigger pool, the mainstream guys, will come in only cautiously." Others confirm that so far institutions have shown interest but not put their money on the table. Jokes Tony Norton, president of the Johannesburg Stock Exchange (JSE): "They come here with their notebooks not their chequebooks."

Ethical and legal considerations have previously been major factors in keeping institutional investors away from the fun. Most European investors now feel free to invest in South Africa. A recent poll by British broker James Capel, one of the few to track the South African market, found that 90% of 1,200 European institutional investors think it "perfectly acceptable" to invest in South Africa. Of the 800 British investors in the poll, one-third had already appointed a manager or analyst to cover the market. For most American investors, however, South Africa still remains off limits. Although US president George Bush lifted the Comprehensive Anti-Apartheid Act (CAAA) last month, 26 states and 76 cities still have sanctions laws, many of which prevent local agencies dealing with financial institutions with investments in South Africa.

Bond issues have not been the only source of capital in the last year or so. For the first time since 1985 long-term, large-scale financings have also been available. South African Airways (SAA), for example, raised $236 million in two deals, the first in late 1989, to finance the acquisition of two Boeing 747-400s. The loan, in the form of a conditional sale agreement, was arranged by Hill Samuel and syndicated among a number of mainly European banks. And in September 1990, Hypobank arranged a $370 million syndicated loan for the purchase of seven Airbus A320s. According to Francois Marx, manager (international treasury) at Transnet, the state corporation which owns SAA, the Airbus deal used a special structure to avoid sanctions rules on European banks lending new money to South Africa. But, he says: "I would not like to elaborate on that."

The market for South African borrowers has improved so much that Marx believes he has many more options available to finance two further 747-400s due for delivery in 1992 and 1993. "All of a sudden there are all sorts of people visiting us again," he says. A loan via a US bank is a possibility. Leasing has become possible for the first time and Marx says he has been approached by Japanese leasing companies such as Orix. The airline still has to pay a premium for its funds, which cost it about 11½% over Libor for an eight-year credit.

Other recent bank financings include locomotives for Transnet and a R550 million project finance credit to fund a cable between South Africa and Madeira for the Department of Posts and Telecommunications (SAPT) completed in two tranches in April and July/August. Says Christoffel Erasmus, general manager finance at SAPT: "We had no problem raising the money and although the cost of funds was not divulged, I can assure you that it was relatively cheap."

South Africa's banks have also found that lines of credit have opened up to them, particularly since the start of this year. Trade finance lines have been easily available for a couple of years but volumes have soared recently and margins have been slashed. Malcolm Chapman, head of treasury and the international division at Absa (the product of the merger this spring of Volkskas and United Bank) says that trade finance lines are "now a flood". Margins have dropped in the last three months, he says, by between ¼% and ½% to Libor plus 1%. The problem now, says Chapman, is not raising the funds but "because economic activity is at such a low ebb, it is difficult to find enough trade to use the money on". At the end of 1990, Absa reported over R1 billion in foreign currency credits lent on customers. Chapman estimates the figure is probably double that now.

The most significant shift in the willingness of foreign banks to lend occurred about six months ago, says Chapman, when non-trade finance lines of less than a year were first made available to him. He also believes he could obtain credits of more than one year at around 1½% over Libor "if we asked for them". He has not yet done so. Most of the credit lines have come from European banks although recently US banks have reportedly been offering forex lines, which did not fall within the CAAA rules because they are not considered to be loans.

Some of the influx of foreign money has found its way into the stock market, where the JSE Industrials index has risen from 3,000 to 4,085 this year. But most observers believe equity finance will be harder to attract than debt. The rise in the index has been concentrated almost exclusively in blue-chip stocks. And indeed the figures for net purchases of equity by foreigners are ambiguous. Humphrey Borkum, chairman of the JSE and principal of brokerage Davis Borkum Hare, says there has been no noticeable inflow. "There has been a turnaround of sentiment but only since about the beginning of July. But half a dozen big wholesale sales have wiped out the inflow." Other brokers question the accuracy of the JSE's data and say they are sure foreign money has come in.


The inflow of money into South Africa is showing up clearly in the country's balance of payments. A net outflow of capital (excluding reserves) of Rl.8 billion in the last quarter of 1990 turned into a net inflow of R800 million in the first quarter of 1991. That was despite repayments of about $200 million due on bond issues and rescheduled foreign loans. The inflow was predominantly of short-term capital: the net inflow of short-term money in the January-March period was R1.4 billion (reversing a Rl.2 billion outflow in the previous quarter) while there was a net outflow of long-term capital of R600 million.

Chris Stals, governor of the Reserve Bank, says that early calculations suggest the net inflow did not continue in the second quarter but that the outflow was small. "It is not impossible," he says, "if the situation continues, that we will have almost a zero outflow by the end of this year." Since known commitments for 1991 total $1.5 billion, that prediction implies an injection of foreign capital of about that amount.

Raising long-term money will prove more difficult. The Eurobond market is the best chance, although what volume of South African paper the market could absorb remains to be tested. Long-term straight bank loans are most unlikely. Banks are required to provision against new money to South Africa (5% in the case of UK banks, for example) because of the debt standstill the country declared in 1985.

The standstill was triggered by the refusal of US banks to roll over short-term debt, on which South Africa was relying excessively. It involved the introduction of the financial rand and the suspension of repayment of commercial bank debt (but not of payment of interest payments, or repayment of, inter alia, bond issues).

Since 1985, the government has negotiated three interim arrangements with its creditors which detailed a partial repayment schedule alongside an extension of the moratorium. The arrangements also allowed certain exit options. Short-term debt could be converted into medium-term loans with definite repayment dates. It could also be converted into property or equity at the financial rand rate and then, through the sale of these assets, repatriated.

The third interim arrangement, agreed in 1990, expires in December 1993. With the changed investment climate, speculation is already rife that the South African government will propose a radical solution that will allow banks to surmount the provisioning problem and begin long-term lending again. One suggestion from a UK banker is that the South Africans could agree to repay the $8 billion left in the standstill in return for the banks agreeing to relend them immediately the same amount voluntarily. Says this banker: "My gut feeling is that the provision requirements will only be around for another 12 months."

Stals at the Reserve Bank admits that he is looking for a radical solution but says that the government is unlikely to do anything before 1993, mainly for political reasons.

Even with the need to provision, there may be ways banks can afford to restart long-term lending. One banker suggested that loans might be available if the borrower redeposited 50% of the money with the lender.

In the meantime, South Africa's big borrowers are all honing their plans to come to the international bond markets. "They will be prolific borrowers again," says Jonathan Pearson, a director of Chartered WestLB.


Paradoxically, the biggest potential borrowers claim they do not need the money. Eskom, for example, has 30% over-capacity in power generation and does not expect to build any more power plants until next century. "For the time being, we just want to keep a presence in the market because we realise how important the international capital markets will be in the next phase," says Kok. Croeser at the DoF says that from a budgetary point-of-view the republic doesn't need the money either.

It may be, however, that the wilier borrowers know the wisdom of disclaiming need for funds in order to keep their costs down. Other para-statals are more open about their needs.

A major potential borrower is Telkom SA, the new name for the telecoms side of the Department of Posts and Telecommunications which will be split in two and made a semi-autonomous, but still government-owned, corporation in October. (Transnet, formerly South African Transport Services, underwent a similar transformation in April 1990.) The change will allow Telkom to link its funding plans into long-term business strategy, rather than simply budget from year to year as before. Telkom's Erasmus estimates that he will need to raise Rl.2 billion-Rl.5 billion a year for capital investment. As much as 75% of that could be borrowed overseas, if market conditions allow. He is considering various credit enhancement techniques, such as linking borrowings directly to cash streams, to ease the way. "We won't go into the markets with a big bang," he says. "We will be very prudent. At least to start with, we will probably go the route of small private placements."

Another borrower looking for funds – at the right price – is the City of Johannesburg, which administers 920,000 inhabitants of parts of the greater Johannesburg area. (Because of the peculiarities of apartheid, areas such as Soweto, with a guesstimated 2 million people, are excluded.) Says deputy treasurer Colin Findlay: "The city would be very keen on borrowing on the Euromarket again when the opportunity presents itself." He is looking to raise R100 million-R200 million in the autumn. The key factor in the decision is rates. Although a domestic issue would cost close to 17%, the premium on forward foreign exchange cover, which is provided at slightly subsidised rates by the Reserve Bank, is 5%-6%. Findlay and others think a domestic issue looks better value.


A likely first time borrower is the Development Bank of South Africa (DBSA). The bank, founded in 1983 by the South African government and the governments of four "independent homelands", works on similar lines to development banks elsewhere. It issued its first domestic bond, a 20-year issue with a nominal value R1.5 billion, in May last year. Some of that issue, confirms Richard Kirkland, group manager finance, ended up in foreign hands and the bank may consider an international issue.

In the bank's favour is its attractiveness to investors worried about the ethics of South African investment. Despite the drawback of having the bantustan shareholders, it invests mainly in poor, black areas of the country and practises positive discrimination in employment. Comments Kirkland: “If the investor thinks he is getting involved with an area that he likes for moral reasons it's the cherry on top of the cake.”

DBSA is also exploring other, ethically-sound, ways of attracting foreign capital. It may create special purpose vehicles to securitise projects and sell the paper to institutional investors.

Such specially-tailored products, structured to meet the peculiarities of financing in South Africa, may be a way of the future. A recent example is collateralised housing investment paper (Chips) developed by the Industrial Development Trust (IDT) with UAL Merchant Bank These represent repackaged housing loans lent by the IDT for low-cost (under R12,500) black housing. The paper is backed by government securities so that principal is guaranteed. Over-collateralisation is structured so that default rates have to reach 50% before the yield begins to be affected.

The uniquely South African twist to what sounds like straightforward mortgage- backed paper (except that the houses are too cheap to allow a legal enforceable mortgage to be charged on them) is in the way the borrowers receive the money. The IDT's agents lend to groups of house-buyers who band together in the form of a savings club. All borrowers sign as co-principal debtors and decide jointly how much each member is allowed to borrow. The lender relies on peer pressure to enforce interest payments.

UAL's Kirkinis wants to target a future issue of Chips at international investors. "We're studying what sort of yield level the international market would bear. One possibility is to issue different tranches with differing levels of risk," he says. "We've also got other projects on the go using the same concept. Watch this space."


These are not the only products available either. South Africa is rapidly catching up with the rest of the world in the field of derivatives. Kirkinis mentions a number of other value-added products that have been sold to foreign investors. His bank repackaged South African gilts with US treasury zeros for investors who were unhappy with pure South African risk but liked the yield. Guaranteed Performance Trusts combine direct equity investments with a backing of gilts. The Elfi (equity-linked fixed income) issues by Transnet, which have standard bull and bear tranches, are also attractive to foreign investors.

The possibility of developing derivatives business is one of the factors attracting new foreign banks to South Africa. There have been only four operating foreign banks in the country for some time: Bank of Lisbon and Bank of Athens, which serve the substantial Portuguese and Greek minorities; the French Bank of Southern Africa, owned 51% by Banque Indosuez with minority stakes held by the Natal Building Society and Barlow Rand; and Société Générale South Africa, until May known as the International Bank of Johannesburg, when the Paris-based bank bought from Bankorp the 50% it did not own already. There are also 32 representative offices; branches are not permitted.

The two French-owned banks are probably fortunate to have a duopoly of the market when foreign interest is on the increase. Both have roughly the same business lines: M&A, securities clearing, foreign exchange, trade finance and derivatives. Both claim to have imported derivatives specialists to boost their expertise.

The attraction of derivatives is that, although the South African banks are relatively sophisticated, the market is too thin with interest rate views all one way. Adds Peter Gray, managing director of SocGen SA: "You used to be able to cover any currency up to seven years through the Reserve Bank. Now it's only up to five years and only in dollars. But [South African] borrowers can't then hedge their exposure in another currency against the dollar – foreign banks will not cover with a South African counterparty. Société Générale would be in a reasonably good position to get that for them."

Other foreign banks are also looking to open up. Standard Chartered, which owned a 38% stake in Standard Bank until it disinvested (for what, it insists, were purely commercial, not political reasons) in 1987, opened a rep office on August 1. The office will be run by Mel Balloch, Stanchart's long-standing head of South African operations. He is a surprisingly senior appointment for a representative. Says Tony Major, head of international banking: "We wanted to put somebody very senior down there. He will recommend after a year or two how we should go: whether we should start a full banking operation, stay a rep office or pull out."

The South African financial press is full of rumours of other banks looking to return. Chase is said to be interested. The Japanese are visiting in force – senior officials from Yamaichi were in Johannesburg at the end of July – and, given the trade links between the two countries, might be expected to open offices soon. But the best bets are the British merchant banks. Morgan Grenfell, Robert Fleming and Schroders are all known to be interested in upping their presence.

South African banks are looking to boost their international presence, too. Until now they have been restricted to trade finance. First National Bank, for example, intends to apply for branch licences in London and Switzerland. A number of other banks already have overseas offices in London and Hongkong. Chris Liebenberg, chief executive of Nedbank, goes a step further and suggests that there might be good strategic reasons for “linking” with a European bank. "We've already had a number of approaches both from Europe and within Africa," he says. The latter suggestion is particularly intriguing but he will only say that the approach was from an African institution outside South Africa.


A gentle re-entry

South Africa wants to come up with a final package on the debt standstill in 1993, says Reserve Bank governor Chris Stals. The financial rand system could be abolished at about the same time. Interviewed by Garry Evans, Stals sketches out the country's approach to the international markets as the barriers lift. And he warns that inflation is not yet under control.

Flows of short-term capital are increasing. What are the prospects for long-term capital?

At this stage South African borrowers find it possible to roll over or extend something like 50% of maturing loans. Where it is not possible, it is not because of any political constraints on South Africa, but because of difficult markets – the margins are not acceptable to the South African borrowers, for example. So the situation has also improved for medium-term capital.

As the political constraints are removed and sanctions dismantled, and the banks are looking at South Africa again with great interest, the pure financial and economic factors – interest-rate differentials, availability of liquidity in the South African market, the credit rating of the country – begin to play an important role again.

Is there any possibility of a recurrence of the situation of 1984/5 when there was an over-reliance on short-term finance and, for political reasons, that dried up?

It is a worry that if we go on borrowing short-term capital to the extent that we have been in the past five months, it could become a problem again. But what we have done so far is that, as the private sector has borrowed more short-term money, the Reserve Bank repaid all its short-term loans. So the country's short-term liabilities have not really increased. The Reserve Bank today has almost zero foreign liabilities. We have unutilised credit facilities available for about R4.5 billion.

So we are not that worried about the amount of short-term liabilities, but if it should continue to increase we will have to worry about it. We have taken a few steps now to discourage – or rather to stop encouraging – short-term borrowings. We have made the cost of forward cover in respect of short-term foreign borrowings more expensive but we have not done this for long-term borrowings. If you take into account the cost of forward cover plus foreign interest rates, it's even more expensive than to borrow in the domestic market. And we will do more if necessary.

In 1984/5 – let's be honest about it – we didn't know the amount of short-term liabilities. A very important change has been introduced since then in that all foreign borrowings then were off the balance sheet. In the new Deposit-Taking Institutions Act it's almost impossible to have anything off the balance sheet. So we know much better what the short-term borrowings amount to. We monitor it on a monthly basis. The bank's supervision department looks at this very carefully.

How important for South Africa is it that you get a facility from the IMF?

We don't really need a facility from the IMF at this stage and in terms of the IMF's regulations we would not qualify for a stand-by facility because we don 't have a balance of payments need. We have quite a good surplus on the current account and the foreign exchange reserves are on a rising trend.

[But] it is really important for us to have a normal relationship with the IMF restored because it could have a very important influence on the policies that we will follow. At this stage, we would be very cautious about restimulating the domestic economy because that could easily lead to an increase in imports and a deficit on the current account and then we could very easily develop a balance of payments problem unless we could rely on an IMF facility. Some people say, why don't you do that, relax on your restrictive domestic policies, let the imports rise and then confront the IMF with an application. But if the IMF says no, what do we do then?

Would there be a strong psychological effect of having an IMF facility on attracting other foreign capital?

One should not exaggerate this but just about every foreign banker that comes into my office asks me when we will have normal relations with the IMF again. If you are a potential lender, you know that if this country must repay the money five years from now and if the country does have a balance of payments problem the first line of resistance will be the foreign reserves. The bankers look at our foreign reserves and they say they are better than they were two or three years ago but you still do not have reserves equal to three months' imports. Your second line of defence will be the IMF. If you do not have access to IMF facilities, there's not much that you can pull out of the hat to support your economy if you have a balance of payments problem. So the bankers will give you a high risk rating.

If lenders know that South Africa does have access to IMF facilities, and they know that South Africa is not using any cent of the IMF [money] but it has the potential to borrow something like R12 billion (or R15 billion after the increase in quotas), obviously that gives them a much greater sense of security. It is an interesting thought that opening up IMF facilities to South Africa may help us not to make use of the facilities.

The only obstacle in the way of having a normal relationship with the IMF is the Gramm amendment. When will that be abolished?

We have practically no problem with the IMF itself. It is only the Gramm amendment, which requires the American executive director to refer any application from South Africa to Congress. That will almost automatically lead to a debate on the South African situation and would embarrass the Bush administration and the IMF and us. So by mutual consent we just stay away, we do not make any application to the IMF. It's been said by a few people that South Africa should make an application to the Fund to test the reaction. But what they don't understand is that we can only make an application once we're in trouble with the balance of payments.

What has been reported in the press makes sense: that the [Bush administration] would be very reluctant to scrap the Gramm amendment before Congress has approved the increase in the IMF quotas for the United States which must be done before the end of this year. [Otherwise] it would be very tempting to the anti-South African groups in America to add a new Gramm amendment to the increase in quotas legislation. So it makes a lot of sense to me that they delay the repeal of the Gramm amendment until later this year or next year.

The discount of the financial rand to the commercial rand has fallen to as little as 6% recently. What are the conditions that would have to be fulfilled for you to abolish the financial rand system?

It is a very welcome development that the discount got so small. We have to look at our overall balance of payments position and our reserves, we have to take account of the fact that we can't go to the IMF if we have a problem. And we have to take account of the fact that we still have many political uncertainties in South Africa. As long as you have the financial rand system in place, it serves as an umbrella. If the foreign investor wants to withdraw, the discount gets bigger, but it doesn't affect our foreign reserves position.


[But] for the longer-term, it doesn't help our foreign reserves or our credit ratings. So we would like to get rid of the system eventually, but we would certainly not be prepared to consider it at this stage.

Our approach at the Reserve Bank – which is not necessarily the same as the minister of finance will follow, and exchange control matters are normally his final decision – would be to start to officially intervene in the financial rand market. The Reserve Bank [might in future] from time to time buy the financial rand with foreign exchange and manage the two exchange rates closely together for some time before we start dismantling the system.

The objection to that approach is that you have the worst of both worlds: you still have the financial rand system and it is also costing you foreign exchange. [But] m a transition period ... we first want to test the volumes in the market, see how much will be needed from foreign exchange reserves to keep the two rates together. If, after a few months, we find that it is not costing us much, then we can go further and start dismantling the system.

This would not be a secret because there is no way that we could do it on a confidential basis because we have to intervene in the markets and give instructions to banks and foreign exchange dealers to buy financial rand on our behalf.

Given the considerable reduction in the discount over the last two years, are you worried that investors might start to take profits and pull out?

Not so much that they will pull out and take profits. There are many investors who wanted to make a short-term profit by investing in the financial rand and have already got out. It's more a fear that adverse political developments could frighten investors and could lead to a new surge in selling of the financial rand.

Just recently, with the small discount, there was also some conversion of debt standstill money into the financial rand market. I was surprised that there were only very small amounts converted. I would have expected more. This proves that the creditors trapped in the debt standstill are evidently satisfied with their position. They are not looking for the first opportunity to get out. They have an opportunity now with the small discount but they don't use it.

But if we abolish the financial rand system, the creditors inside the debt standstill can quite rightly ask, what about us? The two control systems were introduced at the same time, in September 1985, and they serve the same objective in the end: to protect the reserves against a sudden outflow of capital. For the foreign equity investor we designed the financial rand system, for the foreign lender to South Africa, we used the debt standstill arrangement. We have to relax the two systems more or less at the same time.

The next round of negotiations on the debt standstill will take place in 1993. What will be your approach?

It is difficult to say. At that stage there will be about $5 billion left inside the debt standstill. At the end of 1990, the figure was about $6.4 billion and there is about another $1 billion due for repayment up to the end of 1993 and there will be some further conversions into the long-term facility and the financial rand. I don't think it will be wise to start negotiating about that amount before the middle of 1993.

There is one reason [however] why one may consider this: as long as we have a debt standstill most countries require special provisions against new loans made to South Africa. If we can, at that stage, renegotiate the debt standstill so that we get a final, terminal agreement that will no longer be regarded as a debt rescheduling arrangement, one can perhaps consider it.

But it would be so much easier to find a better agreement in 1993, I believe. The amount will be smaller by that time; we and our creditors will know much better what the political situation is; we will most probably by that time have normal relationships with the IMF.

What form could this final agreement take?

It's really just thinking aloud at this stage. One can think of a package deal where perhaps you offer to your creditors some cash, some conversion into a ten-year facility and a three- to five-year repayment programme for the balance – perhaps a third [for each element]. And then you've got rid of the whole system. That would mean about $1.5 billion in each of the three components. I think it shouldn't be difficult in 1993 to come to a final arrangement.

Despite several years of tight money, inflation has hardly moved. Are you confident that inflation is conquered?

No, surely not. The policy we have followed in the past two and a half years succeeded in reducing the inflationary pressures in the South African economy very substantially. Three years ago, we were sitting on a powder keg with a fear that the rate of inflation would go up to 30% and 50% and get out of control. Money supply was increasing at the rate of 27%, bank credit extension was increasing at over 33%, the exchange rate was depreciating by 20% per annum. Everything indicated that we were headed for runaway inflation.

At least that has changed completely. Today, money supply is increasing at below the rate of inflation, the exchange rate is pretty stable and so on. We still measure a rate of inflation more or less on the same level but things do look better. There is at least a possibility that the rate of inflation will come down. [But] I can't be confident to tell you that what we have done last year will certainly result in lower inflation over the next six months.

We did not apply a very restrictive monetary policy – to have a target range for the increase of money supply of 8%- 12% in 1991 is, to my mind, not a very restrictive policy. Why should we tolerate an increase of 12% in the money supply if the real rate of growth in the economy is zero? Our approach deliberately was one of a slow and gradual reduction in the rate of inflation. The alternative could have been to go for a quick kill, but that would have created so much opposition that we would have lost the hard-won independence of the central bank. We have warned the public that this approach will have to go on for a long time. We know that we are not going to get the results immediately.


An economy run on politics not logic

The return of foreign capital to South Africa is essential to get the economy growing again. While trade sanctions did not hurt the country (non-gold export volumes grew on average 7.5% a year between 1984 and 1990), financial sanctions have caused a recession which has lasted 27 months and shows few signs of recovery.


That, at least, is the opinion of almost all South African businessmen and government officials. The logic behind the argument is simple: in order to pay for the chronic deficit on the capital account of the balance of payments (which averaged R4.9 billion between 1985 and 1990) the government has had to run a similar-sized surplus on the current account. This meant restricting economic growth and domestic consumption through tight fiscal and monetary policies. Chris Liebenberg, chief executive of Nedbank, likens the situation to "running a company with no access to overdraft facilities".

The Reserve Bank of South Africa has quantified how much it believes growth has been restricted by the capital outflow. Its model says that, with zero net capital outflow, growth over the last six years would have been 1% higher and an extra 50,000 jobs would have been created (massive unemployment, as high as 40% by some estimates, has been the worst side-effect of the recession).

This analysis is broadly correct. But the argument moves on to less firm ground when it tries to equate a new inflow of capital with an automatic return to sustained economic growth. The Reserve Bank uses its model, for example, to argue that an inflow of capital the same size as the previous outflow would allow growth of 4%. Gerhard Croeser, director-general of the Department of Finance, goes even further: "This seems too low to me," he says. He feels that a big capital inflow could bring growth close to the 5.5% a year needed to absorb all new entrants to the labour market and begin to cut into the unemployment figure.

Others worry, however, whether the structural inefficiencies of South Africa's economy do not forebode long-term stagnation. This school agrees that the recession will bottom at the end of this year or the beginning of next, but suspects that the renewed growth will be only a blip caused by the depth of the downturn. Jokes Liebenberg: "Even a dead cat will bounce if you drop it from a high enough building."

And the structural peculiarities will be hard to get rid of. They include: the huge costs and inefficiencies of the apartheid bureaucracy, which provides too many overpaid jobs for Afrikaners; the most centrally-planned economy and largest state sector of any non-communist developed country (where the government's cautious plans for privatisation have now been put on ice pending a political settlement); the danger of an increase in inflation (which has stayed in the 10%-20% range throughout the last decade) as government spending is boosted prior to the next – vital – election and as black living standards are raised closer to white levels; and an informal economy large enough to make fine-tuning the economy an impossibility – if the informal economy has grown over the last five years from 4% of GDP to 40%, as some economists say, rather than to only 8% as the Reserve Bank thinks, there may have been no recession at all.

At the root of all these problems is the fact that government policy has long been dictated by political not economic logic – although bankers say that during the last two years the government has listened much more to the well-regarded Reserve Bank. One senior banker is more optimistic about a future black government. "I believe the ANC couldn't do worse than the white one has done," he jokes.

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