A London-based hedge fund has entered the highly charged debate on whether South Africa should tap the R497bn gains in its Gold & Foreign Exchange Contingency Reserve Account (GFECRA), showing how it could be done in a way that protects the Reserve Bank’s balance sheet while slashing the government’s debt burden and interest bill.
Since the FM broke the story that the Bank is the custodian of a R497bn “pot” of cash (the GFECRA), reaction has been divided between those who would have the government urgently tap into these reserves to lessen its fiscal constraint and those who believe they should remain sacrosanct.
The GFECRA contains the unrealised (paper) profits or losses incurred by the Bank on the country’s foreign exchange reserve holdings arising purely from changes in the value of the rand. Any net profit/loss accrues to the government in terms of the South African Reserve Bank (SARB) Act.
But transfers can only be done with the approval (or in conjunction with) the Bank governor to safeguard the Bank’s independence and credibility. And though the National Treasury may benefit from the profits in the GFECRA, it is also obligated to recapitalise the Bank in case of any losses.
In most other countries, the central bank pays over some of the net profits earned as a result of valuation adjustments to the national treasury once a year. But in South Africa this has never happened as per a long-standing agreement between the Bank and the Treasury.
Now, thanks to a research paper by Amia Capital economists Annik Ketterle and Pedro Maia, with London School of Economics doctoral student Guido Maia, it is possible to compare South Africa’s unusual treatment of its GFECRA account with international norms — and to quantify the benefits that could be unlocked by conforming to standard international practice.
The paper shows that compared to 20 other central banks, South Africa’s has the largest equity and revaluation buffer as a share of its balance sheet. In fact, the country is an outlier both in terms of the level of central bank equity and the speed at which it has grown.
The 25% devaluation of the rand since 2021 has nearly doubled the size of the Bank’s equity buffer from roughly 4% to close to 8% of GDP. It currently stands at a policy moving R497bn.
According to the paper, most arrangements between central banks and treasuries are based on a simple transfer rule — if there is any profit above a set threshold in the revaluation account then a full transfer takes place.
The authors cite the Swiss National Bank’s framework as a potential model for South Africa as it has a similar institutional arrangement with its department of finance. The Swiss have implemented a rules-based approach that establishes a satisfactory equity buffer below which no transfers can be made and smooths transfers by transferring profits only partially over time.
In South Africa, the authors recommend that the Bank transfer 50% of its equity buffer each year to the Treasury according to a strict transfer rule. This, it finds, could achieve savings of 5 to 20 percentage points of GDP over a 20-year period while still providing robust protection for the Bank’s balance sheet against future rand volatility.
Ideally, it says this rule should stipulate that GFECRA transfers be used only to buy back debt or retire upcoming maturities, arguing that this would have a big, long-lasting impact on the debt stock and the budget, sustainably reducing the government’s interest rate bill by as much as 0.9% of GDP (about R62.5bn).
With the debt ratio rapidly approaching 80% of GDP and interest charges consuming more than 20% of main budget revenue, this is not a trivial consideration.
“The savings achieved in terms of the interest rate bill are substantial and should not be dismissed, even if far from relieving the National Treasury from the responsibility of stabilising a debt trajectory that has been undermining the country’s growth prospects,” say the authors.
A new economics paper finds that South Africa could safely tap into some of the profits in its R500bn rainy-day kitty
— What it means
On the other hand, if the GFECRA were left untapped, it would likely double in size to about 16% of GDP over the next 20 years, the authors’ modelling predicts. In other words, the opportunity cost of not using the funds is only likely to increase over time.
Leaving GFECRA profits idling on the Bank’s balance sheet is an “inefficient” allocation of resources, they argue, given that the Treasury is borrowing at bond yields of close to 13%.
If these profits were transferred to the Treasury, it could have a positive impact on investors’ and ratings agencies’ assessment of the country and lower the government’s bonds’ risk premiums. In fact, they estimate that using close to 8% of GDP of cash could retire as much as 10 percentage points of GDP in government debt, while still keeping the Bank well-capitalised.
Even so, the authors are against 100% profit transfers from the GFECRA, as this could generate outsize intra-government cash flow volatility and potentially large negative equity positions at the Bank.
They also come out strongly against selling foreign exchange reserves, saying that it’s a “common misconception” that this is the only way to realise the unrealised gains on the GFECRA. In fact, it is neither common practice internationally nor a desirable policy as it would generate volatility in currency and money markets and drain a large amount of rand liquidity from the system.
This leaves only two other options, and both involve implementing profit transfers via monetisation — either through a rule enabling partial/full monetisation or one-off transfers that require a negotiation between the Bank and the Treasury each time a GFECRA profit arises.
The problem with one-off transfers is that this would allow for the continued politicisation of the issue. A transfer rule, on the other hand, would automate the process and ensure predictability for the Treasury. Credibility would be enhanced if the rule stipulated that GFECRA resources not be used to fund permanent spending gaps.
In economics, monetisation is a politically charged term. But in this paper, it refers to just the transformation in the composition of the Bank’s liabilities. Quite simply, the GFECRA would be downsized by the transfer amount of choice and that same amount would be credited either at the Treasury’s exchequer account at the Bank or at Treasury’s tax-and-loan accounts with different banks.
“In this strict sense, monetisation has been used by all major central banks,” the authors conclude.
However, as Bank deputy governor Rashad Cassim has explained, distributing GFECRA profits without selling foreign exchange reserves would entail monetisation of the balances and this would entail substantial liquidity-management costs for the Bank.
To address this, the paper recommends that the transfer rule be accompanied by a mechanism through which the Treasury compensates the Bank for the financial sterilisation costs as they arise.
However, this may require amendments to the SARB Act — something the Bank is likely to want to avoid at all costs for fear that it could open the door to other more populist amendments which could interfere with the Bank’s mandate or undermine its independence.
It is possible to use some of [the GFECRA] and the cautiousness of the [Bank] and the Treasury would ensure it’s done in a conservative manner
— Gina Schoeman
The Bank and the Treasury are studying the GFECRA issue and have pulled in international expertise to assist them.
“The issue is not that simple,” Bank governor Lesetja Kganyago told journalists after last week’s Monetary Policy Committee (MPC) meeting.
“The notion that there’s some pot of gold hidden at the Reserve Bank and all that’s needed is to figure out how to get into it and, bingo, all our problems are solved, is very simplistic and, at worst, is actually very reckless in terms of policy.”
The governor stressed that to realise GFECRA gains, the Bank would either have to sell the underlying assets (which would raise questions about the country’s financial sustainability) or monetise it (print money). He went to great lengths to explain the undesirable risks of both.
That said, Kganyago conceded that the current situation of continuing to sit on GFECRA profits, “isn’t sustainable either”, signalling that at some point the GFECRA is likely to be tapped.
“Using the GFECRA is by no means a simple task,” Citi Bank economist Gina Schoeman tells the FM. “There are liquidity issues, policy issues, financial stability issues and political issues that are all being weighed up. [But] it is possible to use some of it and the cautiousness of the [Bank] and Treasury would ensure it’s done in a conservative manner.”
Krutham MD Peter Attard Montalto doesn’t believe the Bank’s guarded reaction amounts to it digging in its heels.
“This is a highly complex area,” he says. “It will take time for the two institutions to find each other.”
He expects them to reach agreement on the portion of the GFECRA that can be safely tapped; on Treasury covering any liquidity-management costs; and on restricting usage to credible items such as large, expensive debt redemptions.
But he thinks they will shy away from initiating any legal amendments, given the political challenges of amending the SARB Act, even though the currency will likely keep on a depreciating trend and so continue to swell the GFECRA’s profits over time.
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