Absence of structural reforms set to weaken state finances
JOHANNESBURG – The South African Reserve Bank (SARB) has warned that the coronavirus pandemic and lack of structural reforms would weaken government finances worse than anticipated and further elevate the risks to the country’s financial system.
The central bank said in its first bi-annual Financial Stability Review yesterday that the pandemic would result in long-term financial stability risks, with banks facing a likely increase in non-performing loans and insurance companies’ higher policy lapses.
SARB said Covid-19 struck the country at a time of severe macroeconomic vulnerability. It said the result could be the worst gross domestic product (GDP) shock in nearly 30 years.
SARB said structural impediments such as skills shortages, infrastructure constraints in the energy sector and policy uncertainty posed a particular risk to economic growth.
It said growth post-Covid-19 would most likely be muted because of the structural constraints.
“The projection of a sharp contraction in 2020 and a relatively weak recovery implies that the level of real GDP in 2022 is likely (to) be lower than that of 2018,” SARB said. “As a result, financial firms could face challenges rebuilding capital buffers if they are worked down over the coming months. Should the economic downturn be deeper or more protracted than currently expected, financial stability risks will escalate.”
The gloomy forecast comes after the bank this month slashed interest rates by 500 basis points for the third time this year, bringing the total cuts this year to 2.5 percent on predictions that the economy was likely to contract more than 7 percent.
SARB said the projection of a sharp contraction in 2020 and a relatively weak recovery implied that real GDP growth in 2022 was likely to be lower than in 2018.
It said the downgrading of the country’s sovereign debt to junk by the major ratings agencies would elevate the government’s long-term borrowing costs and heighten risk aversion across financial markets.
“The sharp increase in the government's funding requirements alongside has resulted in substantially higher government bond yields, particularly for longer-duration debt,” SARB said. “As a result, the spread between short- and long-term borrowing costs is at a historically elevated level. Should longer-term bond yields remain elevated, the government may be forced to adjust its fiscal stance.”
The International Monetary Fund (IMF) has projected that the government Budget deficit would reach 13.3 percent of the GDP this year and 12.7 percent in 2021.
SARB said the macroeconomic impact of the Covid-19 pandemic and precautions to withstand the shocks had been hampered by a lack of fiscal space that had constrained the government's ability to provide stimulus.
It warned that the full impact of the pandemic would only become apparent later or next year.
“The duration of the constraints on economic activity will determine the longer-term risks,” SARB said. “A key risk for the economy is that large-scale business closures and job losses may ensue during the period of Covid-19-related disruption. If this becomes the case, the economy may not recover to its previous level of potential output once the virus has been contained. This could limit future earnings prospects, and debt service capacity, of households and firms.