The view that South Africa should look towards the International Monetary Fund (IMF) to be rescued from the unfolding economic meltdown seems to be growing by the day.
It has been touted in the most unlikeliest of places. Even the new Finance Minister Malusi Gigaba, a proponent of the so-called radical economic transformation, has expressed willingness to engage the IMF.
There is no doubt about the seriousness of South Africa’s economic crisis. The country entered a technical recession after the economy contracted in the fourth quarter of last year and first quarter of this year. Unemployment seems to be rising towards the 30% mark.
And global credit rating agencies are uneasy about South Africa’s economic prospects. After a spate of downgrades early this year, they have threatened further downgrades which will take the country deeper into junk status. While the South African situation is getting more desperate, which calls for desperate measures, the idea to turn to the IMF is a bad idea and must be dismissed. There are a number of reasons why I think this is the case.
First, historical evidence suggests that IMF administered rescue programmes are actually a recipe for disaster. They worsen rather than rescue the situation. Second, to suggest that South Africa’s problems are financial in nature is a dangerous misdiagnosis. It will distract the government from the critical issues it needs to address which have little to do with the finances.
Third, one of the main driving factors of the current economic predicament is a loss of investor confidence. This is linked to other factors like policy uncertainty, political instability within the ruling party and mismanagement of public resources mixed with corruption. An IMF bailout won’t address these problems.
And lastly, hopping onto the IMF programme would disturb the country’s commitment to reforming the global multilateral financial world. South Africa is part of the BRICS bloc which is grooming a new and perhaps alternative multilateral development finance institution called New Development Bank. If anything, South Africa must look to BRICS if it needs financial rescue.
I believe that the solutions to the country’s economic crisis are within. It needs internal discipline to address them – not an external force.
The IMF does not have a good historical record. A view of the many countries which have subjected themselves to the IMF doesn’t inspire confidence. Instead of bailing out countries, it has created a list of countries suffering from debt dependency.
Of all the countries across the world that have been bailed out by the IMF:
11 have gone on to rely on IMF aid for at least 30 years
32 countries had been borrowers for between 20 and 29 years, and
41 countries have been using IMF credit for between 10 and 19 years.
This shows that it’s nearly impossible to wean an economy from the IMF debt programmes. Debt dependency undermines a country’s sovereignty and integrity of domestic policy formulation. The debt conditions usually restrict pro-growth economic policies making it difficult for countries to come out of recession.
IMF’s poor record is partly influenced by the policy choices that it imposes on countries it funds. The IMF policy choices for developing countries, known as a structural adjustment programme, have been widely condemned. The main reason is that they insist on austerity measures which include; cutting government borrowing and spending, lowering taxes and import tariffs, raising interest rates and allowing failing firms to go bankrupt. These are normally accompanied by a call to privatise state owned enterprises and to deregulate key industries.
These austerity measures would cause great suffering, poorer standards of living, higher unemployment as well as corporate failures. The current technical recession would be magnified into a full-blown crisis, leading to even greater shrinking of investment.
South Africa and the IMF
South Africa has always been aware of the dangers of taking IMF money. In December 1993, five months before the country became a democracy, the National Party government, under the guise of transitional executive committee, signed an IMF loan agreement.
When the African National Congress (ANC) came to power after the elections in April 1994 it walked away from the IMF offer. Its concern was mainly that the IMF would undermine the sovereignty of the newly established democracy by imposing inappropriate, policy choices that would have further harmed poor people.
Over the past 23 years South Africa has stayed away from the IMF. There is no reason to change this. In fact there are more reasons today for South Africa to maintain its position.
The BRICS factor
South Africa is set to assume the rotational chair of the BRICS bloc in 2018. The BRICS bloc was formed, in part, to challenge, the dominance of western Bretton Woods institutions – the IMF and the World Bank.
It would be politically naive and economically counterproductive for South Africa to give itself to the IMF. It would undermine South Africa’s integrity and tarnish its place within the BRICS bloc. And it would undermine the idea that the BRICS’ New Development Bank can offer an alternative to the Bretton Woods institutions.
BRICS promises to yield real economic benefits to South Africa because it can leverage trade between the member countries as well as public and private investment from within the bloc.
A better way to deal with the crisis
Advancing any financial assistance to South Africa without addressing the current bad policies would not address the current economic turmoil. Rather, it would result in the country sliding deeper into debt.
And any assistance would be entrusted to a government that has created the crisis because of imprudent policies. The result would be an extension of the crisis because the pressure would have been taken off the government leaving the architecture of the meltdown intact.
What needs to happen is that policymakers need to turn their minds to the real problems. This can simply be done without a bailout.
The planned reinvention of the World Bank may be a mea culpa of sort from the multilateral funding institution. But it is still a bearer of bad news for poor African countries.
The World Bank is looking to migrate from the model that largely relies on member states providing loans for development projects, to one in which it becomes more of a broker of private capital to be invested in development projects.
The World Bank Group President Jim Yong Kim believes that a sizeable portion of private capital lies idle. With proper steps to eliminate unacceptable risks, this capital can be channelled into funding development in poor countries.
Private investors are generally risk-averse. This means that mountains of idle cash remain largely untapped at the expense of real investments. These could generate jobs and green energy as well as reduce poverty, improve health care and extinguish debts that are haunting countries the world over. Kim argues that development finance needs fundamentally to change in speed and scale, growing from billions of dollars in development aid to trillions in investment.
He believes that there are significant financial resources readily available and sitting on the sidelines of capital markets. They generate little in the way of returns, particularly compared to what they could make if invested in developing countries. Private investors lack knowledge about these countries, and their tendency to remain generally risk-averse means that the funds remain largely untapped.
Kim’s argument amounts to an admission that the Bretton Woods system has failed to address gaps in the global capital markets. And that its institutions – the International Monetary Fund and the World Bank – which were established after the second world war to foster international economic cooperation – have failed to support the world’s developmental needs.
But private sector funding won’t help the situation because the much needed developmental investments in Africa are social in nature. Private investments will also be costly, and as a consequence, exploitative.
Weaknesses in Bretton Woods institutions
The Bretton Woods multilateral institutions have been strongly criticised for their corporate led model, which tends to undermine social justice. Over the years they have been focusing on profit oriented investments. Many have impoverished people in emerging economies, particularly in Asia and Africa through displacements, large scale privatisation, natural resource looting and environmental degradation.
Aid and loans from the World Bank and the International Monetary Fund usually come with strict conditions and restrictive policy recommendations. These take away the economic freedom of aid recipients and borrowing countries. They include strict inflation controls, high taxation, large scale privatisations, rapid trade liberalisation and cutting government expenditure on social services.
Conditions on aid and loans usually forfeit states’ authority in governing their own economy, as national economic policies are predetermined under the loan packages. This ultimately shifts regulation of national economies from state governments to the Washington institution in which African developing countries hold little voting power.
The number of emerging countries depending on the World Bank funding has drastically declined over the past ten years. This has been mainly due to increasingly attractive alternative sources of financing. The bank has been rendered irrelevant as private capital flows to the developing world have grown on the back of governments issuing sovereign bonds. Its role has gradually become a mere aid agency dealing with a smaller group of low-income fragile states,
The new generation of institutions spearheaded by emerging market governments led by China is further threatening the traditional multilateral institutions.
This is what lies behind the World Bank’s efforts to reposition itself from being a lender for major development projects relying on funding states, into a broker for private sector investment. This would shift it from being a body that disburses development aid to one that mobilises investment.
But the World Bank’s proposed repositioning will have a number of negative implications on countries in Africa.
First, it will further disadvantage developing nations as most investments in Africa are classified as risky. This means that most investors are unwilling to commit funds for longer time frames. And, given the high risk assessment, borrowing will be expensive. This in turn will push countries further in debt and expose them to exploitation by private lenders.
Second, the repositioning from public to private funding will further cement the World Bank’s business model at the expense of social benefit. This will undermine the role of the state as the primary provider of essential goods and services, such as health care and education.
Last, it will be almost impossible for the bank successfully to mediate between the interests of a global markets system, developing country governments, and people in poverty. This is because projects attractive for private investment are out of the reach of poor people.
There’s no reason to believe that the bank’s envisaged new role will lead to a reduction in poverty. The more likely outcome will be that it once again fails to address international capital market shortcomings.
The New Development Bank recently held its second annual meeting in the Indian capital of New Delhi to discuss the sustainability of financing development projects in its member states.
The multilateral bank was established by the BRICS states of Brazil, Russia, India, China and South Africa. With headquarters in Shanghai, China, it was created to support emerging economies and provide an alternative to the domination of the World Bank and the International Monetary Fund.
But the new bank is already proving to be a replication of the Bretton Woods institutions. This can be seen through the partnerships the new bank is forming as well as its operating posture.
It’s also showing bias towards the development of Asian countries. This is evident from its funding patterns and the recent proposed enlargement of the BRICS bloc. The list of proposed additions includes Pakistan, Bangladesh, Iran, Nigeria, South Korea, Mexico, Turkey, Indonesia, the Philippines and Vietnam. All except three are Asian.
The proposed expansion of the BRICS countries has been justified as a move to strengthen the bloc and fill the void created by rising protectionism in the US. But it has been met with mixed reactions even among member countries. India, for example has expressed its disapproval that BRICS “plus” is China’s ploy to cut New Delhi’s influence in the group by roping in more pro-China countries.
The New Development Bank’s business as usual and its bias towards Asia suggests that it will not become an alternative source of finance. It will not address the key areas of needs for emerging economies like human capital development, poverty alleviation and basic healthcare.
More of the same
The New Development Bank was set up as an alternative to the World Bank and IMF which are viewed to be pushing western agendas. It was to provide a development model that would be sensitive and beneficial to emerging economies. But it’s quickly abandoning this mandate and falling into the trap of operating like the institutions it was created to replace.
In September 2016 the New Development Bank signed partnership deals with the World Bank to co-finance projects. The agreement also aims to facilitate knowledge and staff exchanges. This puts the bank in bed with the institutions it was established to counter.
The bank has also signed memorandums of understanding with the European Investment Bank, European Bank for Reconstruction and Development, the Asian Infrastructure Investment Bank and the Eurasian Development Bank and the International Investment Bank (IIB). The agreements cover co-financing of infrastructure projects, the bulk of which are in Asia.
Perhaps the foundations of the bank were faulty from the start. Its original designers were two former World Bank chief economists, Joe Stiglitz and Nick Stern. Given this history, it’s possibly never going to challenge the world financial order.
Today, the New Development Bank is pushing the corporate-led development model just like the World Bank, the IMF and other Bretton Woods institutions. Their investments are profit-oriented which tends to undermine social justice. Thus similar to the World Bank and IMF, the New Development Bank seems more focused on protecting its investments at the expense of saving the interests of the BRICS citizens.
Over the past decade, the corporate led model has impoverished many people in emerging economies, particularly in Asia. It has led to farmer suicides, large-scale privatization, natural resource looting and environmental degradation.
Funding so far
The New Development Bank has so far made loans of $811 million to entities in four BRICS countries towards energy infrastructure. Of this $300 million went to Brazil, $81 million to China, $250 million to India, and $180 million to South Africa.
For South Africa, the bank has so far not provided any meaningful opportunity to obtain additional finance. The loan of $180 million (R2.6 billion) was given to South Africa’s power utility Eskom to develop 670 MW of power generation and 500 MW worth of renewable energy projects involving independent power producers. This unnecessary loan to an inefficient state owned entity has only contributed to BRICS’s power over South Africa by adding onto the current contingents liabilities dollar-based loans that the government has guaranteed for the next 12 to 20 years.
There are weaknesses in the way in which the New Development Bank works that also raises questions about its intent.
First, the bank’s activities are often shrouded in secrecy. There are no clear official records available to the public about the bank’s activities, decisions and operational guidelines. Analysts have to rely on secondary and tertiary information sources.
Second, the bank is yet to present any socio-economic redress and environmental operational guidelines for communities. This would ensure that its funding does not lead to displacement, evictions, ecological destruction, loss of livelihoods and threats to the basic right to life. These issues have recurred for decades due to projects funded by other multilateral development banks.
Lastly, as a co-financier with development institutions like the World Bank, the bank’s seriousness about promoting transparency, accountability and probity remains questionable.
To strengthen its relevance to emerging economies, the New Development Bank must review the much criticised, inequitable representation of developing countries, especially from Africa. It must also focus more on small-scale investments rather than large-scale infrastructure projects. These often lead to exclusion of people and communities, and aggravate existing vulnerabilities rather than bringing about development.
Misheck Mutize, Lecturer of Finance and Doctor of Philosophy Candidate, specializing in Finance, University of Cape Town and Sean Gossel, Senior Lecturer, UCT Graduate School of Business, University of Cape Town
The idea of establishing an alternative credit rating agency led by the BRICS bloc of countries is gaining momentum. But there are questions as to whether it will prosper given the major challenges it’s bound to face.
Leaders from the bloc made of Brazil, Russia, India, China and South Africa are championing the idea. The idea formerly emerged during the 2015 BRICS summit in Ufa and was affirmed by the Goa Declaration at the 8th BRICS Summit. Most recently South Africa’s President Jacob Zuma said BRICS countries had taken the decision that they could rate themselves, and perhaps others too. The aim would be to ensure a more “balanced view” when ratings are made.
Both Brazil and Russia have recently been downgraded by Moody’s. And for over a year South Africa has lived with a possible downgrade by the “big three” Western credit rating agencies, Standard & Poor’s, Moody’s and Fitch. The big three have faced increasing criticism. Critics claim that the frequent downgrades of developing countries are unjust and serve Western political interests.
BRICS has started engaging financial experts on a business model for the new rating agency as well as what methodology it would adopt.
This isn’t the first time there’s been an attempt to challenge the big three. China, Russia, India and Brazil have all established their own credit rating agencies. But none has ever come close to establishing itself as an alternative.
Will the BRICS initiative be the exception?
Critics of the big three were emboldened after the 2008 financial crisis. The rating agencies were forced to pay over $2.2 billion in fines relating to their complicity in the credit crisis. This further damaged their credibility and heightened accusations, particularly in emerging countries.
Critics have also attacked the rating agencies’ issuer pay model. Under this system credit rating agencies are paid by the institutions being rated (debt issuers) and not by the investors who use the information, creating a conflict of interest. Critics also argue that this entrenches geopolitical biases.
The hope is that a new agency would compensate for the perceived bias in the global financial architecture. It would also create competition and offer investors, issuers and other stakeholders a wider choice and a more diverse view on creditworthiness.
Weakness in the BRICS muscle
Given that BRICS is home to half the world’s population, accounts for more than a quarter of the world’s economic output and has recently set up a nascent New Development Bank, the countries under its banner have, between them, the capacity to establish an influential credit rating institution.
But questions have been raised about whether the new rating agency satisfies a financial need or is politically motivated. And if it will be competent to provide an independent, objective and credible credit rating service based on sound methodology. China has already expressed concerns about the credibility of a new agency. Analysts have also strongly criticised the probable adoption of the existing “issuer-pay” model. This would mean that the current model is simply replicated.
Tough market to crack
Considering that the three major rating agencies control more than 90% of the world’s ratings business, establishing a new one wouldn’t be easy. It could take years, or even decades, to gel.
There have been previous attempts to launch new ratings agencies. All failed to take off. Examples include the Lisbon headquartered ARC Ratings which was launched in November 2013 as a consortium of five national ratings agencies from South Africa, Malaysia, India, Brazil and Portugal. It is yet to release its first sovereign rating. The CARE Rating agency of India, started in April 1993, is still rating small to medium enterprises.
The Global Credit Ratings (GCR) was established in South Africa in 1995. It is only planning to start offering sovereign credit ratings from 2017.
Others that have been launched include:
MARC of Malaysia which has been operational since 1996, but still only covers corporate ratings;
The Hong Kong based Universal Credit Rating Group which was launched in 2014l
Russia’s Analytical Credit Rating Agency (ACRA) which was established in 2015;
the Beijing based China Chengxin Credit Rating Group, established in 1992;
and Dagong Global Credit Rating established in 1994.
None has established itself as an alternative credit rating agency of choice for emerging countries.
The task ahead
The biggest task for a new BRICS credit rating agency will be to convince investors, particularly those from the US and Europe, that the ratings assigned are politically impartial. One way of doing this would be to adopt the “investor-pays” model where investors subscribe to ratings released by the agencies, and the subscription revenues become its source of income. This would ensure transparency and credibility while avoiding conflicts of interests.
But adopting a new model might not fly given that main users of the credit rating information are global pension and mutual funds which currently use at least one of the “big three” rating agencies. They are therefore unlikely to trust any ratings from the new BRICS rating agency with a yet to be tested rating model. Adopting a new model would also be tricky as the BRICS rating agency would need to wield enough influence to be able to attract sufficient subscriptions from international funds.
Finally, investors will be sceptical about the new BRICS rating agency’s ability to compensate for losses in the event that it issues false ratings as the “big three” did in the US. The BRICS agency is likely to be another failed rating agency project unless it can overcome these three hurdles.
Misheck Mutize, Lecturer of Finance and Doctor of Philosophy Candidate, specializing in Finance, University of Cape Town and Sean Gossel, Senior Lecturer, UCT Graduate School of Business, University of Cape Town