## 1zafea2020003

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### The shock and immediate impact
- South Africa has the highest number of COVID-19 cases in sub-Saharan Africa.
- Government lockdown severely depressed domestic demand; global supply disruptions exacerbated existing structural constraints.
- Deteriorating global financing conditions triggered portfolio outflows, impairing a major source of external financing.
- Result: a deep recession unfolding in an economy with high unemployment, poverty, and inequality.

### Policy response — monetary and macro-financial measures
- South African Reserve Bank (SARB) actions:
  - Policy rate cuts: 25 basis points in January; 100 basis points to 5.25 percent in March; 100 basis points to 4.25 percent in April; 50 basis points to 3.75 percent in May (aggregate easing described elsewhere as 275 basis points in 2020).
  - Liquidity and market-support measures on March 20 and March 25: overnight supplementary repo operations, adjustments to standing facility rates, larger weekly refinancing operations, a bond purchase program in the secondary market, and extending main refinancing maturities up to 12 months.
  - Other measures: reduced liquidity coverage ratio from 100 to 80 percent; pillar 2A capital requirement cut from 1 percent to zero; drawdown of capital conservation buffers allowed; guidance on dividends and bonuses to preserve capital buffers.
- Staff advice:
  - Transparently communicate the temporary nature of SARB bond purchases.
  - Closely monitor bank liquidity and capital positions; encourage timely recognition of defaulted restructured exposures and preservation of capital buffers.
  - Increased supervisory attention for smaller banks and introduction of a comprehensive resolution regime as contingency planning.

### Policy response — fiscal measures and composition
- Announced fiscal package: R500 billion (10.3 percent of GDP) with key components:
  - Loan Guarantee Scheme: R200 billion (4.1 percent of GDP)
  - Job creation and support for SME and informal business: R100 billion (2.1 percent of GDP)
  - Measures for income support (tax deferrals, holidays and extensions): R70 billion (1.4 percent of GDP)
  - Support to vulnerable households for 6 months: R50 billion (1.0 percent of GDP)
  - Wage protection (UIF): R40 billion (0.8 percent of GDP)
  - Health and other frontline services: R20 billion (0.4 percent of GDP)
  - Support to municipalities: R20 billion (0.4 percent of GDP)
- Supplementary Budget Review (June 24) scenarios:
  - Passive scenario: deficit rising and public debt exceeding 140 percent of GDP in the next seven years and not stabilizing.
  - Reform scenario: stabilize debt at 87 percent of GDP in FY2023/24 (debt projected to increase from 64 percent of GDP in 2019/20 to 82 percent in FY2020/21).
  - Staff projections in the report are based on the authorities’ reform scenario, endorsed by the President and cabinet.
- Fiscal reprioritization and financing:
  - Reprioritize about R100 billion by delaying investment projects.
  - Provide temporary tax relief and funds (~R155 billion) to protect vulnerable groups and private sector viability.
  - About 30 percent of the announced package (3.2 percent points of GDP) will add to the deficit once excluding contingent liabilities and planned reprioritization.
  - Only half of the announced R200 billion loan guarantee scheme initially expected to be implemented.
  - Projected consolidated gross borrowing needs: 25.2 percent of GDP in FY2020/21.
  - Financing gap (percent of fiscal year GDP): 0.0 (FY19/20), 2.8 (FY20/21), 0.0 (FY21/22).
  - IMF: 1.6 (FY20/21); World Bank: 0.8 (FY20/21); New Development Bank: 0.4 (FY20/21).
  - Memo: Nominal GDP (billions of rand): 5,120 (FY19/20), 4,860 (FY20/21), 5,237 (FY21/22).

### COVID-19 Loan Guarantee Scheme (Box 1)
- Purpose: incentivize banks to lend to SMEs with annual turnover less than R300 million; government and commercial banks share credit risk.
- Size and mechanics:
  - Government initially provided a guarantee of R100 billion to the SARB with option to increase to R200 billion (4 percent of GDP).
  - SARB lends to banks at repo rate (3.75 percent) plus 0.5 percentage point guarantee fee; banks lend to SMEs at repo rate plus 3.5 percentage points.
  - Loss absorption: net margin on the loan portfolio (estimated at 2 percentage points) pooled as first loss buffer; 0.5 percentage point guarantee fee as second buffer; banks absorb third loss up to 6 percentage points of amount loaned; remaining losses borne by National Treasury.
  - Government guarantee recorded as a contingent liability.
- Uptake: uptake has been low since opening on May 12; uptake to date estimated at R11.7 billion in one statement; slower than anticipated.

### Request for IMF support (RFI) and rationale
- Authorities requested a Rapid Financing Instrument (RFI) purchase of SDR 3,051.2 million (100 percent of quota) to be used as budget finance because the pandemic hit with limited fiscal space.
- Staff supports approval; RFI expected to catalyze additional IFI financing and limit regional spillovers.
- RFI would cover 39.9 percent of the external financing needs arising from the shock (2020 shown in financing table: RFI = 4.2 billion U.S. dollars, percent of financing 39.9 in 2020).

### Context — pre-crisis vulnerabilities and buffers
- Pre-existing vulnerabilities:
  - Real GDP growth stagnant in 2019 at 0.2 percent.
  - Budget deficit estimated 6.7 percent of GDP in FY2019/20 (ending March 31).
  - Public debt lifted to 64 percent of GDP in FY2019/20.
  - One third of the deficit driven by transfers to SOEs, mainly Eskom.
  - Stock of contingent liabilities averaged 17 percent of GDP in the five fiscal years ending in FY2019/20.
  - Income inequality among the highest globally.
- Policy buffers:
  - Flexible exchange rate, inflation under control, sound domestic banking system, deep capital markets.
  - Public debt mostly rand denominated with relatively long maturities.

### Recent economic and financial developments (selected facts)
- Financial market stress:
  - Net capital outflows (bonds and equities) exceeded 2 percent of GDP since February’s peak through mid-July.
  - Rand depreciated by 13 percent vis-à-vis the US dollar over that period; earlier the rand depreciated by 31 percent in early-April (weakest on record).
  - Sovereign dollar credit spread more than doubled at one point; South Africa removed from the World Government Bond Index (WGBI) at end-April following Moody’s downgrade.
- Banking sector indicators:
  - Regulatory capital to risk weighted assets: 16.3 (2017), 16.1 (2018), 16.6 (2019), 15.8 (2020 as of March).
  - Nonperforming loans to total loans: 2.8 (2017), 3.7 (2018), 3.9 (2019), 4.0 (2020 as of March).
  - Liquid assets to total assets: 15.1 (2017), 15.6 (2018), 15.0 (2019), 15.9 (2020 as of March).
- Reserves and external sector:
  - Official forex reserves in 2019 were lower than adequate per IMF metrics.
  - Net portfolio and other investment set to be negative in 2020; net FDI inflows negligible.

### Outlook, projections, and labor market (exact values from tables)
- Macroeconomic projections — Real GDP (annual percentage change):
  - 2019: 0.2
  - 2020: -7.2
  - 2021: 2.6
  - 2022: 1.5
  - 2023: 1.5
- CPI (annual average):
  - 2019: 4.1
  - 2020: 3.0
  - 2021: 3.9
  - 2022: 4.3
  - 2023: 4.5
- Unemployment rate (percent of labor force, annual average):
  - 2019: 28.7
  - 2020: 36.4
  - 2021: 36.1
  - 2022: 36.6
  - 2023: 37.1
- Fiscal stance — overall balance (percent of GDP):
  - 2019: -6.3
  - 2020: -13.7
  - 2021: -11.2
  - 2022: -7.9
  - 2023: -5.8
- Primary balance (percent of GDP):
  - 2019: -2.1
  - 2020: -8.9
  - 2021: -6.0
  - 2022: -2.3
  - 2023: 0.2
- Gross government debt (percent of GDP):
  - 2019: 62.2
  - 2020: 78.1
  - 2021: 82.4
  - 2022: 85.4
  - 2023: 87.1
- Consolidated Government Operations (FY basis) — Overall balance:
  - 2019/20: -4.3
  - 2020/21: -16.1
  - 2021/22: -9.5
  - 2022/23: -7.2
- Balance of payments and external financing (selected exact values):
  - Current account balance (billions of U.S. dollars): -10.6 (2019), -5.1 (2020), -6.6 (2021), -8.6 (2022), -10.3 (2023).
  - Current account (percent of GDP): -3.0 (2019), -1.8 (2020), -2.1 (2021), -2.5 (2022), -2.8 (2023).
  - Gross reserves (end of period, billions of U.S. dollars): 55.1 (2019), 52.1 (2020), 50.0 (2021), 50.8 (2022), 52.4 (2023).
  - Gross external financing requirements (billions of U.S. dollars): 68.5 (2019), 60.3 (2020), 58.2 (2021), 63.9 (2022), 72.1 (2023).
  - RFI contribution: 4.2 (2020, billions of U.S. dollars) and shown as 1.5 percent of GDP in financing tables.

### Public Debt Sustainability Analysis (Annex I) — baseline and scenarios
- Baseline:
  - Public debt projected to peak at 87 percent of GDP in FY2023/24 then gradually decline.
  - Gross financing needs (GFNs) projected to average 19.3 percent of GDP during 2020–25 and start falling from 2021.
  - Stock of contingent liabilities averaged 17 percent of GDP in past five years; projected at 26 percent of GDP in FY20/21 assuming full loan guarantee usage.
- Scenario outcomes (selected impacts and exact figures where provided):
  - Persistent low growth scenario: debt-to-GDP would reach about 104 percent of GDP in 2025 if growth permanently lower by 1 percentage point on average during 2021–25.
  - Primary balance shock scenario: cumulative deviation of 11 percent of GDP during medium term would push projected debt past 96 percent of GDP in 2025.
  - Combined macro-fiscal shocks scenario: debt-to-GDP about 104 percent by 2025 and GFNs up about 8 percentage points of GDP by 2025.
  - Contingent liability shock scenario: if all remaining SOE and loan guarantee liabilities were called, debt would rise to about 105 percent of GDP by 2025.
  - Faster implementation of structural reforms scenario: if growth permanently higher by 1 percentage point on average during 2020–25, debt-to-GDP would return below 70 percent by 2025 and GFNs below 15 percent of GDP in 2023.
- Fan-chart and risk thresholds:
  - Under downside-dominated scenario, debt-to-GDP reaches 93 percent by 2025 at upper end of 75th–90th percentile fan chart.
  - Indicative benchmarks: debt benchmark 70 percent of GDP; GFNs benchmark 15 percent of GDP.
  - Stress tests signal high vulnerability: all shock scenarios for debt level and GFNs flash red given high starting debt.

### Key risks and downside scenarios (enumerated)
- Deteriorating health conditions (more severe or prolonged infection spread).
- Failure to implement needed fiscal adjustment and reforms (leading to passive scenario and debt unsustainability).
- Adverse effects of higher domestic government borrowing (higher domestic financing costs and crowding out).
- Mounting social discontent from fiscal tightening and rising unemployment.
- Materialization of contingent liabilities (continued rescues of SOEs, losses from guaranteed loans).
- Increasing private sector balance sheet impairments delaying recovery.
- Weakening business confidence and investor sentiment leading to capital outflows and higher borrowing costs.
- Growing bank vulnerabilities, especially in small and medium-sized banks.
- Worsening global external situation (deterioration in global finance, protectionism, geopolitical tensions).

### Policy priorities and staff recommendations (concise)
- Fiscal:
  - Implement gradual, growth-friendly consolidation of about 5–5½ percent of GDP over next five years to bring deficit to average about 4½ percent of GDP in medium term.
  - Priorities: limit increases in recurrent expenditure (mainly compensation); limit transfers to SOEs; protect health and education; target social assistance.
  - Contingency planning: prepare for larger consolidation if downside risks materialize; phase out temporary relief as pandemic subsides; adopt zero-based budgeting.
- Revenue and expenditure measures:
  - Enhance tax administration and reduce tax incentives as private activity recovers.
  - Rationalize transfers to SOEs; condition support on measurable governance and revenue/expense improvements.
- Structural reforms:
  - Deepen reforms to boost private investment: Eskom turnaround and unbundling, finalize mining legislation, expedite broadband spectrum allocation, clarify land reform, open transport industry, increase retail competition.
- Financial sector:
  - Ensure loan guarantee scheme assists intended beneficiaries while limiting adverse impacts on bank balance sheets and government contingent liabilities.
  - Increase supervisory attention for smaller banks; introduce comprehensive resolution regime.
- Transparency and safeguards:
  - Ensure RFI resources used transparently; publish execution of COVID-19-related expenditures; audit COVID-19 spending within 12 months and publish audit report; publicly disseminate all COVID-19 procurement contracts and beneficial owners.
  - SARB to undergo safeguards assessment; provide SARB audit reports and authorize external auditor discussions with IMF staff; memorandum of understanding between National Treasury and SARB to clarify responsibilities for IMF obligations.

### Staff appraisal and way forward
- Assessment:
  - The authorities’ policy response has been timely and comprehensive; SARB actions and government package are important to limit the economic and social damage.
  - Temporary nature of measures must be respected and contingent liabilities managed carefully.
- Timing and credibility:
  - Supplementary Budget Review (June 24) and cabinet endorsement set out reform scenario; critical elements of fiscal effort should be specified soon and policies announced expeditiously.
  - Approval by parliament at October MTBPS and steadfast implementation will be crucial to regain investor confidence and help restore growth and investment-grade prospects.
- Ultimate objective:
  - Achieve high growth, well-targeted social protection, a lean and efficient public sector, and dynamic entrepreneurship to create employment, fight poverty, and reduce inequality.

*Source: EXECUTIVE SUMMARY and selected sections (1zafea2020003) — South Africa, IMF staff report and Letter of Intent, July 17, 2020.*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### The shock
- South Africa has the highest number of COVID-19 cases in sub-Saharan Africa.
- Government lockdown to mitigate the health impact has had a severe bearing on domestic demand.
- Existing structural constraints are being exacerbated by disruptions in the global supply chain.
- Deteriorating global financing conditions triggered portfolio outflows, particularly at the start of the pandemic, impairing a major source of external financing.
- Result: a deep recession is unfolding in an economy already experiencing protracted subdued growth and deteriorating social conditions, with high unemployment, poverty, and inequality.

### Policy response
- Monetary policy:
  - The South African Reserve Bank (SARB) lowered the policy rate and ensured adequate liquidity conditions in the financial system.
  - SARB cut the policy rate by 25 basis points in January, 100 basis points to 5.25 percent in March, 100 basis points to 4.25 percent in April, and 50 basis points to 3.75 percent in May.
  - On March 20 and March 25 the SARB introduced liquidity and market-support measures including overnight supplementary repo operations, adjustments to standing facility rates, larger weekly refinancing operations, a bond purchase program in the secondary market, and extending main refinancing maturities up to 12 months.
- Fiscal policy:
  - Through a supplementary budget, the government proposed a plan to reprioritize budget appropriations toward health and mitigation spending and devote additional budgetary outlays to protect the poor, the unemployed, and the most affected businesses.
  - Announced measures amounting to R500 billion (10.3 percent of GDP), with key components (Text Table 2):
    - Loan Guarantee Scheme: R200 billion (4.1 percent of GDP)
    - Job creation and support for SME and informal business: R100 billion (2.1 percent of GDP)
    - Measures for income support (tax deferrals, holidays and extensions): R70 billion (1.4 percent of GDP)
    - Support to vulnerable households for 6 months: R50 billion (1.0 percent of GDP)
    - Wage protection (UIF): R40 billion (0.8 percent of GDP)
    - Health and other frontline services: R20 billion (0.4 percent of GDP)
    - Support to municipalities: R20 billion (0.4 percent of GDP)
  - Some public investment projects were postponed and funds reshuffled toward affected sectors.
  - These actions will somewhat limit the economic contraction and its social impact but will significantly push up the budget deficit and debt, which were already under pressure due to declining revenue and rising recurrent expenditure including transfers to weak state-owned enterprises (SOEs).

### The COVID-19 Loan Guarantee Scheme (Box 1 summary)
- Purpose: Incentivize banks to lend to SMEs with annual turnover less than R300 million for operational expenses; government and commercial banks share credit risk.
- Size: Government initially provided a guarantee of R100 billion to the SARB with the option to increase to R200 billion (4 percent of GDP). Uptake has been low since opening on May 12.
- Mechanics: SARB lends to banks at the repo rate (currently 3.75 percent) plus a 0.5 percent guarantee fee; banks lend to SMEs at repo rate plus 3.5 percent spread.
- Loss absorption: Net margin on the loan portfolio (estimated at 2 percentage points) pooled as first loss buffer; 0.5 percentage point guarantee fee as second buffer; banks absorb third loss up to 6 percentage points of amount loaned; remaining losses borne by National Treasury. Government guarantee is recorded as a contingent liability.

### Request for Fund support
- The government has sought financing from international financial institutions (African Development Bank, BRICS New Development Bank, IMF, World Bank) to meet urgent financing needs from COVID-19.
- Authorities requested a Rapid Financing Instrument (RFI) purchase of SDR 3,051.2 million, equivalent to 100 percent of quota, to be used as budget finance because the pandemic has hit the economy in the absence of fiscal space.
- Staff supports approval of this request; IMF support expected to have a catalytic effect and complement authorities’ efforts to contain health and economic impacts.

### Context (pre-crisis vulnerabilities and buffers)
- Pre-existing vulnerabilities:
  - Real GDP growth stagnant in 2019 at 0.2 percent.
  - Budget deficit estimated to have increased to 6.7 percent of GDP in FY2019/20 (ending on March 31).
  - Public debt lifted to 64 percent of GDP in FY2019/20.
  - One third of the deficit driven by transfers to SOEs, mainly Eskom.
  - Stock of contingent liabilities averaged 17 percent of GDP in the five fiscal years ending in FY2019/20.
  - Income inequality among the highest globally.
- Policy buffers:
  - Flexible exchange rate as shock absorber.
  - Inflation under control.
  - Domestic banking system sound and resilient; capital markets deep.
  - Public debt mostly rand denominated with relatively long maturities.

### Recent economic developments (selected facts)
- Financial market stress:
  - Net capital outflows (bonds and equities) exceeded 2 percent of GDP since February’s peak through mid-July.
  - Rand depreciated by 13 percent vis-à-vis the US dollar over that period; earlier the rand depreciated by 31 percent in early-April, reaching its weakest level on record.
  - Sovereign dollar credit spread more than doubled at one point.
  - South Africa was removed from the World Government Bond Index (WGBI) at end-April following the Moody’s downgrade.
- Banking sector:
  - Banks maintained adequate profitability and capital per SARB stress tests, but corporate and household balance sheets weakened (interest coverage ratios weakened in several industries; uptick in non-performing unsecured credit end-2019).
- Monetary conditions and reserves:
  - Inflation declined to below the mid-point of the 3–6 percent target band in 2019.
  - Official forex reserves in 2019 were lower than adequate as measured by the Fund’s reserve adequacy metrics.
  - External current account moderately weaker than implied by fundamentals, suggesting moderate overvaluation of the real effective exchange rate in 2019.

### Immediate response measures (summarized)
- Fiscal, monetary, macro-financial, and regulatory actions taken to preserve activity and financial stability, including:
  - Fiscal reprioritization, wage protection via UIF, expanded social grants, tax deferrals and holidays, and direct health allocations including a Solidarity Fund.
  - SARB liquidity and market support measures and policy rate reductions (detailed above).
  - Macro-financial regulatory relief: liquidity coverage ratio reduced from 100 to 80 percent; pillar 2A capital requirement cut from 1 percent to zero; drawdown of capital conservation buffers allowed; exemption introduced for COVID-19-related credit exposures; guidance on dividends and bonuses to preserve capital buffers.
  - Regulations against price gouging and export controls for goods needed for COVID-19 treatment.

### Outlook and risks (as presented)
- The COVID-19 crisis is expected to significantly weaken the growth outlook and lead to a deep recession with severe social implications and negative regional spillovers through trade, remittances, finance, and revenue transfers to customs union members.
- Epidemiological models predict a peak in the third quarter.
- The authorities outlined a three-phase mitigation strategy:
  - Phase 1: preserve economic activity through immediate and targeted responses.
  - Phase 2: help the economy recover by supporting investment and employment.
  - Phase 3: put the economy on a faster growth path and restore long-term prosperity.

*Source: EXECUTIVE SUMMARY (1zafea2020003) — South Africa, IMF staff report, July 17, 2020.*

### 15.      On June 24 the government presented a Supplementary Budget Review to parliament

### 1zafea2020003 - 15.      On June 24 the government presented a Supplementary Budget Review to parliament

### Supplementary Budget Review: purpose and scenarios
- The Supplementary Budget Review (presented June 24) contains two trajectories: the passive scenario (current policies) and the reform scenario (needed fiscal consolidation and structural reforms).
- Under current policies the document acknowledges: growth would be dismal, the deficit would continue to rise, and public debt would exceed 140 percent of GDP in the next seven years and would not stabilize.
- The reform scenario aims to stabilize debt at 87 percent of GDP in FY2023/24 (debt is projected to increase from 64 percent of GDP in 2019/20 to 82 percent in FY2020/21).
- Staff projections and analysis in this report are based on the authorities’ reform scenario, which has been endorsed by President Ramaphosa and his cabinet.

### Macroeconomic outlook and key projections
- Real GDP growth is projected to contract by 7.2 percent in 2020 (compared to an expansion of 0.8 percent at the time of the 2019 Article IV consultation).
- Inflation: headline inflation is projected at 3 percent in 2020; projected to undershoot the mid-point of the 3–6 percent target range in 2020 but the gap is expected to close gradually.
- Fiscal balance and public debt:
  - Staff projects the consolidated government deficit to rise to about 16 percent of GDP in FY 2020/21, pushing up debt by 18 percentage points of GDP.
  - Public debt is projected to increase from 64 percent of GDP in 2019/20 to 82 percent in FY2020/21 and to peak at about 87 percent of GDP in FY2023/24 before starting to decline under the reform scenario.
- Medium-term fiscal path:
  - Fiscal deficit set to decline to 9.5 percent of GDP in FY2021/22 once one-off measures are phased out and average about 4½ percent in the medium term as the government implements ambitious fiscal consolidation.
- External sector:
  - The external current account deficit is projected by staff to narrow to 1.8 percent of GDP in 2020.
  - As economic activity recovers and interest payments on public debt to nonresidents increase, staff projects the current account deficit to widen to an average 3.4 percent of GDP in the medium term.

### Pandemic impact, policy response, and monetary/financial measures
- Economic drivers of the 2020 contraction:
  - Nationwide lockdown impact on all economic sectors; declines in investment, exports, and private consumption partially offset by lower imports.
- Monetary and bank regulatory measures (Text Table 3 summary — measures and intended impacts):
  - Repo rate: Reduced the repo rate by 275 basis points — Reduced short-term borrowing costs.
  - Government bond market liquidity: Started purchases of government bonds in the secondary market — Restored bond market trading liquidity.
  - Capital requirements: Reduce the Pillar 2A capital requirement from 1 percent to zero and allowed banks to draw down the conservation buffer after consultation with the Prudential Authority — Expected to support lending.
  - Dividends: Provide guidance on dividends and cash bonuses distribution to encourage banks to preserve capital buffers — Expected to help banks conserve capital.
  - Liquidity coverage ratio (LCR): Reduced LCR from 100 percent to 80 percent — Expected to support lending.
- Staff assessment and advice:
  - SARB’s purchases of government bonds have helped ease pressure on yields and supported private sector absorption of government debt; staff recommends transparently communicating the temporary nature of these operations to maintain investor confidence and avoid risks to the inflation mandate.
  - Progressive monetary easing and regulatory forbearance are expected to encourage bank lending, though overall private sector credit is anticipated to weaken considerably.
  - Staff advises closely monitoring bank liquidity conditions following reductions in minimum requirements and encourages banks to timely recognize all defaulted restructured exposures (regulatory capital and IFRS9 perspective) and preserve capital buffers.
  - Staff recommends ensuring the loan guarantee scheme assists intended beneficiaries while limiting adverse impacts on bank balance sheets and government contingent liabilities.

### Fiscal measures, composition, and financing needs
- Supplementary budget amendments to FY2020/21:
  - Reprioritize resources primarily from non-essential acquisition of goods and services and delay investment projects (about R100 billion).
  - Provide temporary tax relief and funds to limit the recession’s impact on the vulnerable, ensure basic services, and support private sector financial viability (about R155 billion).
  - About 30 percent of the announced package (3.2 percent points of GDP) will add to the deficit, once excluding contingent liabilities and planned spending reprioritization.
  - Only half of the announced R200 billion loan guarantee scheme is initially expected to be implemented.
- Borrowing and gross financing needs:
  - Projected consolidated gross borrowing needs are expected to reach 25.2 percent of GDP in FY2020/21.
  - Financing mix in the absence of external issuance includes: issuance of short-term securities (mainly absorbed by domestic banks), issuance of longer-term rand-denominated bonds, drawdowns of deposits in the financial system, and borrowing from IFIs.
- Fiscal financing and sources (Text Table 6 selected figures, percent of fiscal year GDP):
  - Total revenue and grants: 29.1 (FY19/20), 29.2 (FY20/21), 29.2 (FY21/22), 29.2 (FY22/23)
  - Total expenditure: 35.7 (FY19/20), 35.9 (FY20/21), 36.0 (FY21/22), 35.8 (FY22/23)
  - Overall balance: -6.5 (FY19/20), -16.1 (FY20/21), -9.5 (FY21/22), -7.2 (FY22/23)
  - Primary balance: -2.4 (FY19/20), -11.2 (FY20/21), -4.3 (FY21/22), -1.5 (FY22/23)
  - Gross Financing Needs Consolidated Government: 14.6 (FY19/20), 25.2 (FY20/21), 20.7 (FY21/22)
  - Sources of Financing Consolidated Government: 14.6 (FY19/20), 22.4 (FY20/21), 20.7 (FY21/22)
  - Issuance of MLT Debt: 7.5 (FY19/20), 9.3 (FY20/21), 8.0 (FY21/22)
    - Local Currency MLT Issuance: 6.0 (FY19/20), 9.3 (FY20/21), 7.1 (FY21/22)
    - Foreign Currency MLT Issuance: 1.5 (FY19/20), 0.0 (FY20/21), 0.9 (FY21/22)
  - Issuance of ST Debt: 7.3 (FY19/20), 10.7 (FY20/21), 11.0 (FY21/22)
  - Financing Gap: 0.0 (FY19/20), 2.8 (FY20/21), 0.0 (FY21/22)
  - IMF: 1.6 (FY20/21)
  - World Bank: 0.8 (FY20/21)
  - New Development Bank: 0.4 (FY20/21)
  - Memo item: Nominal GDP (billions of rand): 5,120 (FY19/20), 4,860 (FY20/21), 5,237 (FY21/22)
- External financing and RFI:
  - In 2020, net portfolio and other investment are set to be negative and net FDI inflows negligible.
  - The RFI purchase would cover 39.9 percent of the external financing needs arising from the shock.
  - Text Table 7 (billions of US dollars, selected):
    - Balance on current account: -10.6 (2019), -5.1 (2020), -6.6 (2021)
    - Balance on goods and services: 1.8 (2019)
    - Trade balance: 2.7 (2019), 9.3 (2020), 7.3 (2021)
    - Balance on income: -9.9 (2019), -9.2 (2020), -11.4 (2021)
    - Balance on financial account: 10.0 (2019), -5.4 (2020), 4.5 (2021)
    - Portfolio Investment: 9.1 (2019), -4.8 (2020), 4.3 (2021)
    - Overall balance (including E&Os): 1.8 (2019), -10.5 (2020), -2.1 (2021)
    - RFI: ... (2019), 4.2 (2020), 0.0 (2021) — Percent of Financing: ... (2019), 39.9 (2020), 0.0 (2021)
    - FX reserves drawdown: -1.8 (2019), 3.0 (2020), 2.1 (2021)
    - World Bank: ... (2019), 2.0 (2020), 0.0 (2021)
    - New Development Bank: ... (2019), 1.0 (2020), 0.0 (2021)
    - AfDB: ... (2019), 0.3 (2020), 0.0 (2021)

### Risks and downside scenarios
- Prominent downside risks include:
  - Deteriorating health conditions: more severe or prolonged infection spread would further reduce supply and demand, tighten financial conditions, and worsen social conditions.
  - Failure to implement needed fiscal adjustment and reform: absence of consensus would lead to the passive scenario, threatening debt sustainability and generating destabilizing effects such as inflation or financial repression.
  - Adverse effects of higher domestic government borrowing: increased short-end issuance could lead to higher domestic financing costs and greater bank purchases, crowding out lending.
  - Mounting social discontent: fiscal tightening and rising unemployment could jeopardize growth revival and increase poverty and inequality if not mitigated by timely, well-targeted relief and pro-employment policies.
  - Materialization of contingent liabilities: continued rescues of SOEs (particularly Eskom) or losses from guaranteed bank loans would add spending pressures. The stock of contingent liabilities would amount to about 26 percent of GDP by the end of FY2020/21 assuming the full amount of credit under the loan guarantee scheme is granted.
  - Increasing private sector balance sheet impairments: worse-than-expected corporate performance and rising financing costs would delay a recovery anchored on private investment.
  - Weakening business confidence and investor sentiment: lack of credibility in implementing the reform scenario would increase capital outflows, raise borrowing costs, and hurt recovery.
  - Growing bank vulnerabilities: weaknesses in small and medium-sized banks exposed amid subdued growth could generate contagion and reduce financing space for recovery.
  - Worsening external situation: deterioration in global financial conditions, increased protectionism, and intensified geopolitical tensions could undermine the recovery.

### Policy discussions, priorities, and staff recommendations
- Fiscal composition optimization and priorities (authorities’ stated fiscal priorities, LOI ¶13, 14):
  - Rationalize compensation: the wage bill has been rising faster than the cost of living; authorities plan to renegotiate the final year of the current wage agreement with unions to achieve savings in the wage bill of about 0.7 percent of GDP to facilitate increased transfers to low-income households. If a court overturns this decision, additional savings would be needed.
  - Transfers to SOEs: government will maintain budgeted transfers in FY2020/21 to service debt but intends to condition them to measurable progress in revenue generation, expense reduction, and governance improvements.
  - Infrastructure spending: temporarily curtailed except for essential investments.
  - Social grants and unemployment compensation: temporary expansion of grants (including to unemployed youths) to be targeted transparently using the national ID and means-testing systems (LOI ¶22).
- Staff recommendations:
  - Target relief to those most affected while reducing budget pressure from less important outlays.
  - Continue transparent communication on temporary SARB market operations to maintain investor confidence.
  - Closely monitor bank liquidity and capital positions; encourage timely recognition of defaulted restructured exposures and preservation of capital buffers.
  - Ensure loan guarantee scheme assists intended beneficiaries while limiting adverse impacts on bank balance sheets and government contingent liabilities.
  - Increased supervisory attention for smaller banks; introduce a comprehensive resolution regime as part of contingency planning.
  - Deepen structural reforms to boost private investment, address BOP difficulties, accelerate implementation of Eskom’s operational and financial turnaround, finalize mining legislation, expedite broadband spectrum allocation, provide clarity on land reform, open transport industry to private sector, and increase retail competition to support SMEs.
- Upside scenario:
  - Steadfast implementation of reforms could improve confidence, attract private investment, boost growth more than expected, improve the debt-to-GDP ratio, reduce financing requirements and costs, and create virtuous macro-fiscal feedback loops.

*Source: IMF staff report (Supplementary Budget Review and associated analysis).*

### 29.      Improving the business environment will also require determined efforts to strengthen

### 1zafea2020003 - 29.      Improving the business environment will also require determined efforts to strengthen

### Fiscal consolidation and public sector balance sheet
- Staff recommended a gradual and growth-friendly but sizable reduction of the consolidated government deficit.
- This consolidation will require implementation of fiscal measures of about 5–5½ percent of GDP over the next five years.
- Together with the impact of the growth recovery, these measures would allow the deficit to decline to average levels of about 4½ percent of GDP in the medium term.
- Needed measures include:
  - limiting increases in recurrent expenditure, mainly compensation;
  - limiting transfers to SOEs;
  - limiting ill-targeted subsidies;
  - pursuing a recovery of productive public investment;
  - protecting outlays for health and education and well-targeted social assistance.
- Authorities’ intentions and actions (LOI ¶14):
  - let the temporary relief package lapse as the pandemic subsides;
  - make permanent some of the COVID-19 related cuts in non-essential outlays;
  - take any additional measures to restore fiscal and debt sustainability in line with their reform scenario;
  - move to a zero-based budgeting method to reposition spending in line with the post-COVID-19 reality.

### Contingency planning and revenue-side measures
- Staff highlighted the potential for materialization of downside risks and the need for contingency plans.
- If the pandemic produces further economic damage or other risks materialize, post-COVID-19 fiscal consolidation would need to be larger and reforms deeper.
- Authorities expect planned expenditure streamlining to be complemented by enhanced tax revenue from the economic recovery aided by better tax administration (including leveraging anti-money laundering tools to investigate tax crimes).
- Staff called for a reduction in tax incentives once increased private sector activity takes place encouraged by the reforms.
- Budgetary provision: the budget includes additional COVID-19-related allocations to the contingency reserve to address additional needs that may emerge.

### Debt sustainability and structural reform
- Debt sustainability critically hinges on sustained implementation of policies to address underlying fiscal and structural weaknesses.
- The intended reduction in the fiscal deficit and reform implementation are expected to boost the medium-term growth potential—and put debt on a downward trajectory.
- Risks to debt sustainability include:
  - large gross financing requirements;
  - significant contingent liabilities;
  - implementation risks of the ambitious reform scenario.
- Authorities intend to seek consensus for the introduction of a fiscal rule to target a debt objective and complement the existing primary expenditure ceiling.
- Private investment target: attract more private investment to lift its contribution to growth from its anemic pre-COVID-19 level (0.1 percentage points in 2019).
- Revival of growth requires steadfast reform implementation.

### Monetary policy, financial stability, and BOP support
- Preserving price and financial stability will remain the SARB’s key objective.
- As the economy recovers and inflation moves up to the mid-point of the target band, the monetary expansion is expected to be wound down gradually.
- The SARB will continue to let the flexible exchange rate act as the first line of defense and leverage recent emergency tools to maintain adequate domestic liquidity conditions and financial stability, while paying attention to their potential inflationary impact.
- Rationale for the RFI purchase:
  - COVID-19 added pressures to the capital account and exacerbated BOP difficulties.
  - With real GDP growth turning deeply negative and fiscal position deteriorating, RFI resources will contribute to fill urgent BOP needs and could prevent possible erosion of official forex reserves.
  - The RFI purchase will also limit regional spillovers and catalyze additional IFI financing (LOI ¶3).
  - An upper credit tranche Fund-supported program is not necessary because the BOP gap is expected to close within a year as the immediate impact of COVID-19 subsides and intended policies are implemented.
- Capacity to repay:
  - The RFI purchase and other COVID-19-related disbursements will increase the already high debt-to-GDP ratio.
  - Authorities intend to gradually stabilize and turn around the debt trajectory in the medium term.
  - While adding about 1.5 percent of GDP to the current debt stock ratio, the RFI amortization will not increase debt service obligations in a material way.

### Transparency, procurement, and safeguards
- Authorities will ensure that resources from the RFI are used transparently (LOI ¶22).
- Public financial management context:
  - South Africa has a strong public financial management system and is a leader in budget transparency.
  - The public procurement system has been revamped; the digital procurement platform allows transparency in dissemination of procurement announcements and allocated contracts, monitoring of contract allocation, and assessment of awarded companies’ financial status as well as their ultimate beneficiaries.
- Commitments on COVID-19-related spending transparency:
  - Regularly publishing the execution of COVID-19-related expenditures vis-à-vis the adjustment budget by type of spending.
  - Auditing all COVID-19-related expenditure, including ex-post evaluation of delivery, within 12 months and publishing the audit report on the Auditor General’s website.
  - Publicly disseminating all COVID-19-related procurement contracts and allocation (with details about awarded companies and their beneficial owners).
- Safeguards (LOI ¶21):
  - Authorities will undergo a safeguards assessment of the SARB.
  - Authorities will provide staff with the SARB's audit reports and authorize the SARB's external auditors to hold discussions with staff.
  - A memorandum of understanding between the National Treasury and the SARB clarifies responsibilities to timely service the financial obligations to the IMF.

### Staff appraisal, risks, and the way forward
- Economic impact and outlook:
  - South Africa’s economy has been severely hit by the COVID-19 crisis.
  - The health crisis is causing human suffering and financial distress.
  - Domestic economic disruption, falling external demand, and overall financial market uncertainty have triggered a severe contraction in business activity and are expected to create a deep recession this year, with a full recovery only expected in the medium term.
  - The acute decline in consumption and investment, alongside fiscal support needs, will result in a sharp, albeit temporary, deterioration in domestic revenue mobilization and an increase in public expenditure.
- Assessment of policy response:
  - The authorities’ policy response has been timely and comprehensive.
  - The SARB’s upfront action to soothe liquidity conditions and temporarily provide regulatory relief contributed to stabilization of financial markets.
  - The government’s sizable package targets the health sector, the poor, the unemployed, and SMEs that do not have alternative sources of financing.
  - It is important that the temporary nature of these measures be respected and that related contingent liabilities be carefully managed.
  - Proactive bank regulation and supervision, particularly for small banks, is crucial.
- Challenges and priorities going forward:
  - COVID-19 has exacerbated economic vulnerabilities built over the last decade, particularly on the real economy and the fiscal position.
  - Once COVID-19 is behind, there is a pressing need to restore economic fundamentals by consolidating the fiscal position and streamlining SOE operations.
  - Complementary action: introducing an explicit debt target.
  - Increasing medium-term growth potential requires higher private investment, improved governance, lower entry barriers to product markets, and a more flexible labor market to support job creation.
  - Fiscal consolidation and growth-enhancing structural reforms will be crucial to reversing the current upward debt trajectory.
  - Substantial uncertainty and significant downside risks remain; should these risks materialize, fiscal consolidation and structural reform efforts would have to be larger.
- Timing and credibility:
  - The Supplementary Budget Review presented to parliament on June 24 outlines a medium-term reform scenario establishing the fiscal path necessary to keep debt sustainable, and has been endorsed by the cabinet.
  - Critical elements of the fiscal effort should be specified soon and concrete policies to attain the reform scenario should be announced expeditiously.
  - Approval by parliament of these policies at the time of the October MTBPS and their steadfast implementation will be crucial to allow South Africa to benefit from higher economic growth and help the country regain its investment grade status over time.
- Ultimate objective:
  - High growth, well-targeted social protection, a lean and efficient public sector, and dynamic entrepreneurship are the combination to create employment, fight poverty and reduce inequality in South Africa.

*Source: IMF staff report on South Africa (excerpt).*

### 41.      Against this backdrop, an IMF purchase under the RFI in the amount of SDR

### Against this backdrop, an IMF purchase under the RFI in the amount of SDR 3,051.2 million (100 percent of quota)

### Rationale for the RFI purchase
- IMF purchase under the RFI in the amount of SDR 3,051.2 million (100 percent of quota) is warranted.
- Purpose of RFI:
  - Help address the urgent BOP needs that has emerged from COVID-19.
  - Provide the government with urgently needed financing to address the health and social implications of the economic downturn.
  - Avoid a severe economic disruption while giving time to the authorities to advance longstanding reforms.
  - Limit regional spillovers.
  - Play a catalytic role as the authorities engage with other IFIs.
- Assessment: While risks to the outlook are substantial, South Africa’s capacity to repay the Fund is adequate.

### Macro-financial effects observed (selected descriptive findings)
- Nonresidents sold local currency-denominated bonds and equities; public sector external funding cost jumped.
- The rand weakened to a record level; government bond trading liquidity thinned and yields soared; rand volatility surged.
- Business activity plummeted amid a national lockdown, prompting policy responses including rate cuts and liquidity support.

### Macroeconomic projections (selected indicators, exact values from tables)
- Real GDP (annual percentage change):
  - 2019: 0.2
  - 2020: -7.2
  - 2021: 2.6
  - 2022: 1.5
  - 2023: 1.5
- CPI (annual average):
  - 2019: 4.1
  - 2020: 3.0
  - 2021: 3.9
  - 2022: 4.3
  - 2023: 4.5
- Unemployment rate (percent of labor force, annual average):
  - 2019: 28.7
  - 2020: 36.4
  - 2021: 36.1
  - 2022: 36.6
  - 2023: 37.1

### Fiscal stance and public debt (exact values)
- Overall balance (percent of GDP):
  - 2019: -6.3
  - 2020: -13.7
  - 2021: -11.2
  - 2022: -7.9
  - 2023: -5.8
- Primary balance (percent of GDP):
  - 2019: -2.1
  - 2020: -8.9
  - 2021: -6.0
  - 2022: -2.3
  - 2023: 0.2
- Gross government debt (percent of GDP):
  - 2019: 62.2
  - 2020: 78.1
  - 2021: 82.4
  - 2022: 85.4
  - 2023: 87.1
- From Consolidated Government Operations (percent of GDP, FY basis):
  - Overall balance:
    - 2019/20: -4.3
    - 2020/21: -16.1
    - 2021/22: -9.5
    - 2022/23: -7.2
  - Gross government debt:
    - 2019/20: 56.5 (in percent of GDP reported in Table 2)
    - 2022/23: 86.0 (in percent of GDP reported in Table 2)

### Balance of payments and external financing (exact values)
- Current account balance (billions of U.S. dollars):
  - 2019: -10.6
  - 2020: -5.1
  - 2021: -6.6
  - 2022: -8.6
  - 2023: -10.3
- Current account (percent of GDP):
  - 2019: -3.0
  - 2020: -1.8
  - 2021: -2.1
  - 2022: -2.5
  - 2023: -2.8
- Gross reserves (end of period, billions of U.S. dollars):
  - 2019: 55.1
  - 2020: 52.1
  - 2021: 50.0
  - 2022: 50.8
  - 2023: 52.4
- Gross external financing requirements (in billions of U.S. dollars):
  - 2019: 68.5
  - 2020: 60.3
  - 2021: 58.2
  - 2022: 63.9
  - 2023: 72.1
- Sources of financing (selected items, in billions of U.S. dollars):
  - New borrowing and debt rollover:
    - 2019: 66.8
    - 2020: 68.8
    - 2021: 49.8
    - 2022: 55.8
    - 2023: 63.9
  - RFI contribution shown in table:
    - 2020: 4.2 (in billions of U.S. dollars) and shown also as 1.5 percent of GDP

### Indicators of capacity to repay the IMF (exact values and assumptions)
- Assumes RFI disbursement in July 2020.
- IMF obligations based on prospective credit (in millions of SDRs):
  - Principal:
    - 2022: 381.4
    - 2023: 1525.6
    - 2024: 1144.2
  - Charges and interest (SDRs):
    - 2020: 24.0
    - 2021: 32.9
    - 2022: 33.0
    - 2023: 32.9
    - 2024: 22.4
    - 2025: 6.0
- Total IMF obligations based on existing and prospective credit (in millions of SDRs):
  - 2020: 24.1
  - 2021: 33.2
  - 2022: 33.2
  - 2023: 414.6
  - 2024: 1548.2
  - 2025: 1150.4
- IMF credit outstanding (end of period, in millions of SDRs):
  - 2020: 3051.2
  - 2021: 3051.2
  - 2022: 3051.2
  - 2023: 2669.8
  - 2024: 1144.2
  - 2025: 0.0
- IMF credit outstanding (end of period, in millions of U.S. dollars):
  - 2020: 4214.5
  - 2021: 4233.6
  - 2022: 4248.2
  - 2023: 3727.3
  - 2024: 1601.6
  - 2025: 0.0
- IMF quota: 3051.2 (SDR) and RFI disbursement equals 100 percent of quota.

### Financial sector indicators (selected exact values)
- Regulatory capital to risk weighted assets:
  - 2017: 16.3
  - 2018: 16.1
  - 2019: 16.6
  - 2020 (as of March): 15.8
- Nonperforming loans to total of loans:
  - 2017: 2.8
  - 2018: 3.7
  - 2019: 3.9
  - 2020 (as of March): 4.0
- Liquid assets to total assets:
  - 2017: 15.1
  - 2018: 15.6
  - 2019: 15.0
  - 2020 (as of March): 15.9

*Source: IMF staff report content and tables provided in the supplied PDF content.*

### Annex I. Public Debt Sustainability Analysis

### Annex I. Public Debt Sustainability Analysis

### Context
- The COVID-19 crisis has significantly increased South Africa’s government debt and debt service obligations.
- Public debt was already high before the crisis due to persistent weak growth, high fiscal deficits, and the materialization of contingent liabilities from SOEs.
- Public debt is projected to peak at 87 percent of GDP in FY2023/24 and then gradually decline as relief measures are phased out and fiscal consolidation and structural reforms take hold.
- Gross financing needs (GFNs) are projected to average 19.3 percent of GDP during 2020–25 and start falling from 2021.
- The outlook is subject to significant downside risks: the uncertain nature of the pandemic and the global recovery; increased contingent liabilities; and implementation risks to fiscal consolidation and reform.
- Risk mitigants include rand denomination and average long maturities of debt and a deep local institutional investor base; debt sustainability critically hinges on sustained implementation of policies to address underlying fiscal and structural weaknesses.

### Recent developments and drivers
- Revenue had been recovering before the crisis but will be negatively affected by the pandemic.
- Current expenditure had drifted up and is further pressured by emergency measures.
- Declining revenue and spending pressures are pushing up the national government deficit, increasing public debt to an estimated 82 percent of GDP in FY2020/21.
- GFNs are set to increase from 11.5 percentage points of GDP in FY2015/16 to about 24 percent of GDP in FY2020/21.
- The stock of contingent liabilities averaged 17 percent of GDP in the past five years and is projected at 26 percent of GDP in FY20/21.
  - Almost 25 percent of the increase is explained by SOE loan guarantees.
  - 45 percent reflects a new loan guarantee scheme to support enterprises during the pandemic.

### Baseline projections
- Debt-to-GDP ratio trajectory:
  - Projected to rise to about 87 percent of GDP and start to decline gradually from 2024.
  - Short-term deterioration driven by the deep recession in 2020 and emergency COVID-19 measures resulting in an unprecedented national government deficit level.
  - Deficit expected to decline significantly in FY2021/22 as temporary fiscal support unwinds and the economy begins to recover.
  - Medium-term deficit reduction anticipated from automatic revenue stabilizers as growth picks up; permanent rationalization of some FY2020/21 spending; subsequent fiscal consolidation; and structural reforms’ impact on growth.
- GFNs outlook:
  - Given adverse initial conditions, GFNs are expected to remain sizable during the projection period as high deficits persist.
  - GFNs are anticipated to exceed 16 percent of GDP, on average, in 2021–25 despite favorable maturity and currency structure of the debt.
  - GFNs are projected to be met by domestic financing sources (primarily non-bank financial institutions), non-residents, and resources from IFIs.

### Staff assumptions underlying the DSA (Box A1.1)
- Data coverage:
  - Calculations based on the national government’s main budget (central government) consistent with authorities’ debt coverage.
  - Methodology excludes provincial governments, social security funds, extra-budgetary institutions, and SOEs (SOE indebtedness has increased rapidly and is excluded).
- Macroeconomic assumptions:
  - Real GDP growth projected to decline by 7.2percent in 2020 (compared to growth of 0.2 percent in 2019) due to: (i) a severe lockdown; (ii) an external demand shock; and (ii) a tightening of financial conditions.
  - Growth projected to bounce back in 2021-22 and gradually increase to about 2.3 percent in 2025 as structural reforms reinvigorate activity.
  - GDP deflator expected to average 4.1 percent in 2020–25.
- Fiscal assumptions:
  - Debt projections include stock-flow adjustments to capture discounts on new issuance of existing benchmark bonds and valuation effects on inflation-linked and foreign currency denominated debt.
  - Primary deficit projected to be broadly in balance in 2023 and be in surplus in 2024.
  - Intended fiscal consolidation predicated on an expenditure-to-GDP downward trajectory driven by: (i) phasing out of emergency measures; (ii) wage containment action; (ii) tight control over goods and services expenditure; (iii) rationalization of transfers to public entities; and (iv) reduction in financial assistance to SOEs, especially Eskom.
  - Revenue projected to recover gradually as growth recuperates and improvements in tax administration and tax policy measures take hold.

### Downside risks to the baseline
- Growth over-projection:
  - The crisis impact could be higher than expected, making growth projections optimistic and posing an upside risk to debt-to-GDP forecasts.
  - Growth forecasting errors in the past have been on the optimistic side but usually within the interquartile range.
- Underestimated primary balance pressures:
  - Upward pressure on the primary balance could stem from lower-than-anticipated revenue collection and/or higher-than-expected spending pressures including because of a prolonged pandemic and challenging wage negotiations.
  - Primary balance projections have not been systematically biased.
- Higher interest rates:
  - Higher borrowing costs may arise from declines in EM risk appetite and/or increased risk perceptions derived from credibility concerns about the growth-enhancing strategy, particularly if delays occur.
- Larger contingent liabilities:
  - Weak SOE and SME balance sheets could trigger further government support or lead to calls on guarantees on loans.

### Debt composition and mitigating characteristics
- Low shares in foreign currency: 10 percent in 2019.
- Short-term instruments: 11 percent in 2019.
- Average term to maturity: about 12 years.

### Scenario analysis and impacts
- Persistent low growth scenario:
  - If growth were permanently lower than in the baseline by 1 percentage point on average during 2021–25, the debt-to-GDP ratio would reach about 104 percent of GDP in 2025.
  - Scenario factors in adverse impact of lower tax revenue elasticities and higher interest rates as well as denominator effects of lower GDP.
- Primary balance shock scenario:
  - If the primary balance improved more gradually than in the baseline, deviating by a cumulative 11 percent of GDP during the medium term, projected debt would surpass 96 percent of GDP in 2025.
  - A temporary shock to growth with magnitude of one-standard-deviation in 2021 and 2022 would lift debt-to-GDP to almost 89 percent.
- Combined macro-fiscal shocks scenario:
  - Combination of standard shocks to growth and interest rates, a primary balance shock (temporary deterioration equivalent to one half of the 10-year historical standard deviation), and an exchange rate shock (consistent with the maximum movement over the past 10 years and an exchange rate pass-through of 0.25) would increase the debt-to-GDP ratio to about 104 percent by 2025 and increase GFNs by about 8 percentage points of GDP by 2025.
- Contingent liability shock scenario:
  - If all remaining SOE and loan guarantee scheme liabilities were called, debt would rise to about 105 percent of GDP by 2025.
  - Highlights direct risks from contingent liabilities and indirect risks via investor confidence and borrowing costs.
- Faster implementation of structural reforms scenario:
  - If growth becomes permanently higher than in the baseline by 1 percentage point on average during 2020–25 due to deeper reform implementation, the debt-to-GDP ratio would return to below 70 percent of GDP in 2025 and GFNs would be below 15 percent of GDP in 2023.
  - Scenario accounts for favorable effects of higher tax revenue elasticities and lower interest rates as well as denominator effects of higher GDP on spending.

### Risk assessment summary
- All shock scenarios for the debt level and gross financing needs flash red given the already high debt starting point in the baseline.
- Mitigating factors: large domestic institutional investor base, low share of foreign currency, and low share of short-term debt.
- Additional risk factors: high bond spreads (slightly below 600 basis points on average in the last three months), elevated external financing requirements, and relatively high share of debt held by non-residents.

*Annex I. Public Debt Sustainability Analysis*

### 8.      The fan charts highlight the importance of adopting decisive policies to reduce

### 8.      The fan charts highlight the importance of adopting decisive policies to reduce downside risks and the probability of debt distress

### Fan-chart findings and risk thresholds
- Under a scenario in which downside shocks are predominant, debt-to-GDP ratio reaches 93 percent of GDP by 2025 (using the upper end of the 75th–90th percentile fan chart).
- If shocks are symmetric to both up and downsides, the probability of the debt exceeding the same high level is reduced and the probability of better than baseline outcomes increases significantly.
- Indicative risk-assessment benchmarks used in the framework:
  - Debt benchmark: 70 percent of GDP.
  - Gross financing needs benchmark: 15 percent of GDP.
- Heat-map signaling: cell highlighted yellow if benchmark is exceeded in a stress scenario but not baseline; red if benchmark is exceeded in the baseline; green if benchmark not exceeded.
- Benchmarks and thresholds referenced in stress context (as enumerated in figures and notes):
  - Bond spreads: 200 and 600 basis points.
  - External financing requirement: 5 and 15 percent of GDP.
  - Change in share of short-term debt: 0.5 and 1 percent.
  - Public debt held by non-residents: 15 and 45 percent.
  - Share of foreign-currency denominated debt: 20 and 60 percent.
- Contingent liability shock scenario for South Africa: calling of all remaining SOE loan guarantees plus contingent liabilities of the loan guarantee fund. The standard financial sector contingent liability shock is not triggered because three-year cumulative increases of credit-to-GDP or loan-to-deposit ratio do not exceed thresholds (15 percent of GDP for credit-to-GDP; 1.5 for loan-to-deposit).

### Baseline DSA projections and key debt dynamics (selected series)
- Nominal gross public debt (in percent of GDP): 43.2, 56.7, 62.2, 78.1, 82.4, 85.4, 87.1, 86.8, 85.0 (2018–2025 sequence shown).
- Public gross financing needs (in percent of GDP): 10.7, 11.6, 14.7, 21.5, 21.2, 20.7, 19.0, 17.2, 16.2 (2018–2025 sequence shown).
- Sovereign spread indicators shown: EMBIG (bp) 526; 5Y CDS (bp) 316 (as labeled).
- Real GDP growth (in percent): 1.6, 0.8, 0.2, -7.2, 2.6, 1.5, 1.5, 2.1, 2.3 (2018–2025 sequence shown).
- Inflation (GDP deflator, in percent): 6.1, 3.9, 4.1, 3.0, 3.9, 4.3, 4.5, 4.5, 4.5 (2018–2025 sequence shown).
- Nominal GDP growth (in percent): 7.8, 4.7, 4.2, -4.3, 6.6, 5.9, 6.1, 6.7, 6.9 (2018–2025 sequence shown).
- Effective interest rate (in percent): 7.5, 7.0, 7.0, 7.2, 6.8, 6.8, 7.1, 7.2, 7.2 (2018–2025 sequence shown).
- Change in gross public sector debt (cumulative, in percent of GDP): 2.9, 3.7, 5.4, 16.0, 4.3, 3.0, 1.7, -0.3, -1.8 (2018–2025 sequence shown).
- Identified debt-creating flows (cumulative, in percent of GDP): 3.5, 4.8, 5.5, 14.8, 4.7, 3.1, 1.6, -0.4, -1.8 (2018–2025 sequence shown).
- Primary deficit (in percent of GDP): 2.2, 0.6, 2.7, 8.3, 6.0, 2.8, 0.3, -1.4, -2.6 (2018–2025 sequence shown).
- Primary (noninterest) revenue and grants (in percent of GDP): 24.2, 25.6, 25.7, 23.6, 23.3, 24.7, 25.3, 25.8, 26.2 (2018–2025 sequence shown).
- Primary (noninterest) expenditure (in percent of GDP): 26.4, 26.3, 28.4, 31.9, 29.3, 27.5, 25.6, 24.5, 23.6 (2018–2025 sequence shown).
- Automatic debt dynamics (contribution in percent of GDP): 0.0, 2.0, 1.3, 7.6, 0.1, 0.7, 0.8, 0.4, 0.2, 9.8 (series as presented).
- Real interest rate contribution and real GDP growth contribution to debt dynamics are reported separately in the DSA methodology notes and tables.

### Stress-test outcomes and alternative scenarios (high-level)
- Stress tests reported include: Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Shock, Contingent Liability Shock, Permanent Low Growth, and Upside (Permanently Higher Growth) scenarios.
- Under downside-dominated (asymmetric) distributions, debt paths worsen markedly (example: debt-to-GDP reaching 93 percent by 2025 at upper end of 75th–90th percentile).
- Upside scenario (Permanently Higher Growth, PHG) shows substantially lower projected gross public debt and public gross financing needs relative to baseline over 2020–2025.
- Contingent liability shock and combined macro-fiscal shocks materially increase gross public debt (in percent of GDP and percent of revenue) and public gross financing needs under their respective projection paths.

### Policy responses, relief measures, and financing (from Letter of Intent)
- IMF support request:
  - Request for approval of financial support under the Rapid Financing Instrument (RFI) in an amount of SDR 3,051.2 million (100 percent of quota).
  - Request that, upon approval, the full amount be made immediately available to the National Treasury account at the South African Reserve Bank (SARB) as budget support.
- Economic impact and outlook statements:
  - Expect output to fall drastically in 2020 and take more than three years to recover to pre-crisis levels.
  - Unemployment will exceed 30 percent.
  - Formal sector job losses are expected to exceed one million.
- Relief package and financing:
  - Relief package amounting to R500 billion or more than 10 percent of GDP.
  - Direct impact of the fiscal package on the consolidated budget: R185 billion.
  - R101 billion of existing expenditure commitments reprioritized and shifted towards COVID-19-related interventions.
  - Remaining spending financed through use of cash balances and borrowing from multilateral institutions (around US$7–7  .5 billion).
- Specific relief and policy measures:
  - Six-month top-ups of social security grants, food security, and other distress relief.
  - Temporary employment relief support through the unemployment insurance fund.
  - Additions to health services; funding for municipal services (cleaning, sanitizing, provision of clean water); school sanitization and preparedness.
  - Support to small businesses and workers and to critical public entities; tax deferral measures and payment holidays.
  - Credit guarantee scheme for small and medium-sized firms: implemented in phases over a minimum of 2 years; SARB will provide initial funding; fiscus to backstop and guarantee credits for an initial amount of R100 billion, up to a limit of R200 billion.
- Monetary policy and financial stability measures by SARB:
  - Monetary Policy Committee (MPC) cuts: 275 basis points so far in 2020, taking the repo rate to 3.75 percent.
  - In real terms, policy rate now negative and well below the estimated real neutral rate of about 2 percent.
  - SARB actions to support markets and credit: (1) expanding liquidity provision to banks through new lending facilities; (2) providing finance for the credit-guarantee scheme to support SMEs; (3) purchasing government bonds on the secondary market to ensure orderly market functioning; (4) releasing capital buffers and relaxing provisioning requirements for banks to keep credit flowing.

*Source: IMF staff and Letter of Intent excerpts in the supplied content.*

### 9. Despite these efforts, GDP is projected to contract by over 7 percent in 2020. The growth

### 9. Despite these efforts, GDP is projected to contract by over 7 percent in 2020. The growth

### Growth outlook and pandemic impact
- GDP is projected to contract by over 7 percent in 2020.
- The growth projection is premised on a gradual relaxation of the restrictions associated with the lockdown.
- The peak in the infection rate is expected for end of 2020Q3.
- The steepest economic contraction is forecast to occur in 2020Q2.
- Even after the relaxation of lockdown restrictions, the recovery of investment, exports and imports is expected to be gradual.
- Growth is forecast at 2.6 percent and 1.5 percent in 2021 and 2022, respectively.
- In an alternate statement, GDP growth is projected to contract by 7.2 percent in 2020.
- Economic performance in 2019: growth of 0.2 percent.
- Number of COVID-19 cases as of July 22, 2020: 394 948.
- Unemployment rate at end-Q1 (pre-pandemic impact): 30.1 percent.
- Formal sector job losses from the pandemic are expected to exceed one million.

### Inflation, exchange rate, and external sector
- Despite sharp depreciation of the rand against the US dollar since January, inflationary pressures are projected to remain well contained.
- Annual average headline CPI inflation is expected to gradually return to the midpoint of the target band during 2020–22.
- Current account deficit is projected to be around 1.8 percent of GDP in 2020 due to large net income payments.
- A temporary external financing need of about US$10.5 billion is likely to emerge in 2020.
- Authorities intend to cover this need through the use of reserves and financing from IFIs, including the African Development Bank, the BRICS New Development Bank, the IMF and the World Bank.
- The authorities do not intend to introduce or intensify exchange and trade restrictions.

### Fiscal impact and public debt
- FY2020/21 budget deficit (pre-revisions) was 6.8 percent of GDP.
- Revenue is estimated lower by around R304 billion (or 6.3 percent of GDP) compared to the budget.
- National government deficit is now estimated at around 14.6 percent of GDP in FY2020/21.
- In a parallel statement: domestic revenue shortfall of over R300 billion is forecast.
- Public debt path: ratio of public debt to GDP projected to rise from 63.5 percent in FY2019/20 to 81.8 percent in FY2020/21.
- Public debt-to-GDP projected to peak at 87.4 percent of GDP in FY 2023/24.
- Authorities propose fiscal consolidation measures to allow public debt to decline after peaking.
- Authorities seek to introduce a debt ceiling in addition to the nominal spending ceiling currently in place.

### Emergency financing and financing strategy
- Authorities request a purchase under the RFI in the amount of SDR3,051.2 million, equivalent to 100 percent of quota.
- Secured emergency financing from the New Development Bank and from the African Development Bank and plan to seek additional funding from other development partners.
- Anticipated government borrowing needs over upcoming months will be substantial due to capital outflows, higher financing costs, and additional spending.
- Financing strategy for temporary external financing need of about US$10.5 billion includes reserves and IFI financing.

### COVID-19 relief, fiscal package, and support measures
- Broad fiscal relief package amounting to R500 billion (10.3 percent of GDP) to support healthcare spending and cushion the impact of the crisis.
- Additional allocations towards public health at the national, provincial, and local government spheres.
- Package includes funding for a large temporary increase in social grants and funding for the Social Relief of Distress grant.
- Additional funding availed for unemployment insurance payments.
- Other measures include tax deferral and payment holidays.
- A loan guarantee scheme amounting to R200 billion has been set up to assist businesses; administered by the SARB and guaranteed by the National Treasury.
- Uptake on the loan guarantee scheme to date is estimated at R11.7 billion; uptake is slower than anticipated.
- Scheme revisions include adding a ‘business restart’ option and clarifying bank lending criteria.

### Monetary policy and financial stability (SARB actions)
- The Monetary Policy Committee reduced the policy rate by 275 basis points between March and July, taking the repo to 3.50 percent, its lowest level on record.
- The SARB provided additional lending instruments to ensure bank liquidity and conducted government bond purchases in the secondary market.
- Volumes of liquidity provided have tapered off as conditions have normalized.
- Capital and liquidity buffers have been temporarily reduced to give banks more scope to extend credit.
- The SARB has provided regulatory guidance for dealing with borrowers affected by the COVID-19 shock and encouraged banks to forgo dividend payments.
- The SARB will preserve its inflation objective and aim to anchor inflation expectations around the mid-point of the 3-6 percent target range.
- Adjustments in policy stance will aim to ensure inflation does not accelerate above the 4.5 percent midpoint on a sustained basis.
- SARB’s active balance sheet policies will be unwound over time in line with the planned transition of the monetary policy implementation framework.
- Bank regulatory allowances will be reversed, in time, as conditions normalize.
- The SARB will undergo a safeguards assessment as soon as feasible; authorities will provide audit reports and authorize IMF staff to engage with external auditors as needed.
- A memorandum of understanding between the SARB and the National Treasury clarifies responsibilities for timely servicing of financial obligations to the IMF.

### Structural reforms and measures to restore growth
- Reforms guided by "Economic Transformation, Inclusive Growth, and Competitiveness: Towards an Economic Strategy for South Africa."
- Reform priorities:
  - Modernizing and reforming network industries (electricity, road, rail, ports and telecommunications) to lower costs and increase efficiency.
  - Re-orienting trade policies and pursuing greater regional integration to boost exports, employment and innovation.
  - Lowering barriers to entry to make it easier for businesses to start, grow, and compete.
  - Supporting labor-intensive sectors such as tourism and agriculture to achieve more inclusive growth.
- Product market reforms to remove barriers to domestic and foreign investment, followed by reforms to support job-rich growth.
- Encourage firm entry, leverage public-private partnerships in a fiscally responsible way, and reduce regulatory obstacles to investment.
- Revamp skills framework, give firms greater ability to hire labor, and undertake education reforms to make it easier for first-time workers to find a job.
- Specific focus on addressing Eskom’s problems:
  - Near-term focus: (1) improving the fleet’s efficiency to reduce risks of load shedding; (2) stabilizing Eskom’s financial situation by spending wisely on procurement and compensation and enhancing revenue collection from municipalities; and (3) continuing to encourage private sector participation.
  - Planned unbundling to enable greater efficiencies and reduce fiscal risk posed by Eskom.
- Telecommunications: expedite allocation of broadband to increase competition and reduce the cost of data and develop digitalization.

### Governance, public financial management, and SOE oversight
- Meaningful reforms being implemented in the South African Revenue Service, the Public Investment Corporation, and other institutions.
- New leadership appointed in various public entities; policies and procedures under review; prosecution agencies given additional capacity.
- New procurement legislation to consolidate rules and management of the public procurement system within one framework to be presented to parliament during the current fiscal year.
- Support to SOEs will be strictly conditional on meeting key performance indicators to improve operational and financial health; process initiated with Eskom and to be extended to all SOEs.
- Authorities committed to transparently plan, use, monitor and report all COVID-19 related spending:
  - Publish regularly the execution of COVID-19-related expenditures.
  - Audit such expenditure, including ex-post valuation of delivery, within 12 months of the end of the fiscal year, to be performed by the Auditor General and publish the findings.
  - Publicly disseminate all COVID-19-related procurement contracts and allocation (with details about awarded companies and their beneficial owners).
- Authorities committed to reducing government guarantees and closely monitor contingent liabilities in line with guarantee reporting guidelines for national departments and state-owned enterprises.

### Budget process and medium-term fiscal framework
- Supplementary budget review submitted to parliament on June 24, 2020 sought approval of the COVID-19 relief package and presented a medium-term stabilization scenario as the basis for the October MTBPS baseline projections.
- Temporary relief measures will be phased out as the pandemic wanes; some expenditure cuts implemented to make room for relief measures will become permanent or be replaced by other cuts.
- From FY2021/22 onwards, authorities will take action to reverse the upward trajectory of the public debt-to GDP ratio.
- October MTBPS and the process leading up to the February 2021 budget will propose fiscal consolidation measures to allow public debt to decline after peaking at 87.4 percent of GDP in FY 2023/24.
- Implementation of zero-based budgeting for national and provincial departments to reduce dependency on previous budgets and better align revenue and expenditure.
- Measures include further reductions in the wage-to GDP ratio, rationalization of transfers to SOEs, and streamlining of subsidies.
- Revenue-side measures include strengthening enforcement to enhance tax compliance, alongside other revenue measures.

### Commitments to the IMF and transparency to stakeholders
- South Africa does not have outstanding credit from the IMF and its capacity to repay the RFI purchase is adequate.
- Authorities intend to meet financial obligations to the IMF on a timely basis.
- External and public debt sustainability indicators will not change significantly as a result of the RFI purchase; authorities will take necessary measures to maintain debt sustainability.
- Authorities agree to the publication of all documents submitted to the Executive Board in relation to the RFI request.

*Source: Content unit 1zafea2020003 (PDF chapter/section).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1zafea2020003.pdf_