## 1zafea2022002

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### Indicators of Rising Sovereign Risks in South Africa
- Sovereign CDS (external credit risk in US dollar terms):
  - Rose to around 430 basis points in 2015–16.
  - Rose to around 530 basis points in 2020 during COVID-19-related global market turmoil.
  - Trading at around the upper end of the “normal” range relative to its 2010–19 performance (200–300 basis points).
- Sovereign debt-to-GDP ratio:
  - Around 70 percent (reflecting the recent GDP revision).
  - Significantly above previous peak of around 45 percent registered in the 1990s.
- Local currency sovereign term premia:
  - Remains at around its historical high.
- Swap spread:
  - South Africa’s swap spread has been negative.
  - Narrowed from around –370 basis points during worst of COVID-19 market turmoil to around –200 basis points in early-December 2021.
  - Remains wider than previous levels of around –100 basis points and far outside the “normal” range based on historical performance.
- Local Currency Sovereign Risk Premium (LCSRP):
  - Estimated LCSRP is comparable to previous highs including the one registered in 2015–16.
- Actual yield differential to implied counterpart:
  - Moderated from more than 460 basis points in spring of 2000 to around 350 basis points.
  - Remains significantly above previous highs of around 100 basis points and the upper end of the “normal” range of around 70 basis points.
  - Had already widened prior to COVID-19 as the Eskom situation started to worsen.

### Sovereign–Financial Nexus: Drivers, Bank Holdings, and Risks
- Why banks hold domestic sovereign debt:
  - HQLA eligibility, liquidity requirements, collateral for central bank operations and secured wholesale funding, benchmark for pricing, and income source when other income underperforms.
- Regulatory discretion:
  - Basel standards provide national discretion on bank treatment of domestic sovereign debt (risk weights, large exposures, market risk, credit risk mitigation).
- Authorities’ policy actions during stress:
  - Liquidity extension to banks, direct purchases of government debt, conditional commitments to purchase government debt by central banks; use of financial repression and moral suasion.
- South Africa-specific incentives:
  - HQLA eligibility, shortages of other HQLA eligible assets, and phasing out of the SARB’s committed liquidity facility (CLF).
  - The largest six banks on average hold close to 90 percent of HQLA in Level 1 unencumbered assets (mainly domestic government securities and central bank reserves).
  - Largest banks act as primary dealers and market makers in sovereign debt markets.
- Historical bank holdings (top 6 banks, ~a little over 90 percent of system assets):
  - 1990s: holdings moderated from 6–8 percent of assets.
  - Early-2008: nearly 4 percent of assets.
  - End-2011: around 8 percent of assets (bonds ~60 percent).
  - January 2021: somewhat above 12 percent of assets (increase driven mainly by bond holdings; bonds’ share rose to 75 percent).
- Other banks:
  - Early-2008: somewhat below 5 percent of assets.
  - January 2021: nearly 25 percent of assets (increase mainly due to T-bill holdings; T-bills’ share rose to around 70 percent).
- Nonbank financial institutions:
  - 1990s: close to 35 percent of assets in government securities.
  - 2000s: around 15 percent.
  - Mid-2020: rose moderately to 17 percent (driven by OFIs including mutual funds and collective investment schemes).
- Cross-country positioning as of September 2020:
  - South African bank holdings of government bonds were somewhat below the cross-country median of 129 countries, but above levels in Brazil, Mexico, and Turkey.
  - South African nonbanks were positioned somewhat below the cross-country median of 62 countries, similar to Turkey and above Mexico.
- Key risks from the nexus:
  - Absent fiscal consolidation and structural reforms, risks to both the financial system and sovereign increase.
  - Weak private investment, weak demand for bank credit, and weak broader economic activity amplify risks.

### Nonbanks, Nonresidents, Funding Costs, and Stress Scenarios
- Holdings patterns:
  - Nonbanks and nonresidents holdings appear relatively high.
  - Banks increased government bond holdings as a share of the total stock during COVID-19, but still remain below the EME median.
  - Nonbank holdings declined through early-2010s but remain in the top quartile.
  - Nonresident holdings rose from around the median in the early-2000s to the top quartile in the mid-2010s and have remained there despite sales during COVID-19.
- Implications for funding costs and valuation risk:
  - Banks tend to increase holdings when the yield curve steepens.
  - Makrelov et al. (2021) suggests higher fiscal risks prompt banks to increase capital, making it more expensive to hold such bonds.
  - Valuation and volatility risks could increase the likelihood of large valuation losses.
  - Example stress-test finding: widening of external sovereign credit spreads by 200 basis points would lead to a fall in the aggregate capital ratio by some 3 percentage points.
  - Funding cost feedback: banks demand higher yields to hold sovereign debt when more vulnerable, raising sovereign funding costs.
- Channels of spillovers from sovereign to banks:
  - Exposure channel: falling sovereign prices reduce collateral value and can raise bank wholesale funding costs; example estimate: a 10 percent valuation loss on a sovereign bond portfolio (representing 10 percent of the bank’s assets, assuming 6½ percent leverage ratio) would imply a 15 percent reduction in the capital ratio (Dell’Ariccia et al., 2018).
  - Safety net channel: contingent liabilities can materialize if fiscal space is limited; sovereign downgrades pass to bank ratings, increasing funding costs.
  - Macroeconomic channel: higher deficits and debt can raise sovereign and domestic interest rates, hurting bank balance sheets.
- Channels of spillbacks from banks to sovereign:
  - Direct effect: government intervention to manage a banking crisis converts contingent liabilities into realized liabilities, worsening debt outlook.
  - Indirect effect: banking-sector developments affect growth, primary balance, and interest rates, potentially deepening recessions.
  - Home bias effects: high home bias can delay fiscal consolidation; empirical illustration shows a relatively high banking sector home bias is associated with a substantially weaker average primary fiscal balance when debt is 80 percent of GDP (South Africa’s debt was 70 percent of GDP in 2020).

### Empirical Evidence on Banking Crises Costs and South Africa’s Resilience
- Historical international evidence:
  - Median output losses from banking crises: 35 percent of GDP in high-income countries and 14 percent of GDP in low- and middle-income countries.
  - Median increase in public debt in the four years after a banking crisis: a little over 20 percent of GDP in high-income countries and 16–17 percent of GDP in low- and middle-income countries.
  - Extreme fiscal cost examples: Indonesia’s fiscal costs in the Asian financial crisis exceeded 50 percent of GDP; Iceland and Ireland’s fiscal costs during the global financial crisis exceeded 30 percent of GDP.
- Drivers of higher fiscal costs:
  - Higher bank leverage and reliance on external wholesale funding prior to crises.
  - Full guarantees of bank liabilities increase average direct fiscal costs.
  - Higher quality supervision, credible safety nets, and swifter government intervention tend to lower direct fiscal costs.
- South Africa’s position:
  - Banks have strong capital and liquidity buffers and are well regulated; they navigated the Global Financial Crisis and the COVID-19 pandemic well.
  - Joint IMF–World Bank FSAP stress tests show resilience to adverse shocks.
  - Nonetheless, rising public-sector deficits and debt amid increased sovereign risk premia raise concerns about large bank holdings of domestic sovereign debt.

### Policy and Supervisory Recommendations to Mitigate the Nexus
- First line of defense:
  - Fiscal consolidation and structural reforms to reduce sovereign debt supply, boost medium-term growth, improve banks’ lending opportunities, and strengthen bank capital buffers.
- Strengthen safety nets and resolution frameworks:
  - Finalize the Financial Sector Laws Amendment Bill (FSLAB) to improve the bank resolution framework and introduce a deposit guarantee scheme.
- Carefully calibrated regulatory measures (noted during 2021 FSAP):
  - Increasing risk weights on sovereign bond holdings:
    - IRB banks have already increased risk weights on domestic sovereign debt holdings.
    - Under national discretion, a (relatively low) risk weight may be applied to domestic sovereign debt denominated and funded in domestic currency, mindful of pro-cyclical effects.
  - Applying Pillar 1 or 2 capital surcharges:
    - Surcharges could apply on holdings above thresholds, calibrated to reflect perceived risks and discourage excessive concentration while limiting unintended side-effects.
  - Introducing quantitative measures to reduce concentration:
    - Caps on concentration risk could create ‘cliff effects’ if banks rapidly approach limits; calibration must consider this risk.
- Implementation principles:
  - Gradual introduction, careful calibration, clear communication.
  - Consider introducing measures after normalization of COVID-19-related prudential requirements.
  - Provide reasonable transition periods and announce envisaged near-term measures with transition timelines.
- Caution on unintended consequences:
  - Avoid onerous concentration limits or measures that are pro-cyclical, excessively reduce liquidity, or pressure bond markets during downturns.
- Complementary actions:
  - Regulatory efforts must be supported by fiscal consolidation and structural reforms.

### State-Owned Enterprises (SOEs): Size, Performance, and Fiscal Risks
- SOE prevalence and economic role:
  - SOEs dominate utilities, transportation, communications, and developmental financial services.
  - SOEs’ share in real gross capital formation averaged 13 percent of total in the last five years.
  - SOEs’ assets amounted to 34 percent of GDP at end FY19/20.
  - Nonfinancial SOEs account for 86 percent of total assets; financial SOEs account for the remainder.
- Concentration:
  - Nonfinancial SOEs: Eskom, Transnet, and Telkom represent about ¾ of assets, 80 percent of revenue, and 97 percent of loan debt (11.4 percent of GDP).
  - Financial SOEs: Development Bank of Southern Africa, Industrial Development Corporation, and Land Bank account for 94 percent of assets, 95 percent of revenue, and 91 percent of loan debt (2.8 percent of GDP).
- Fiscal support and contingent liabilities:
  - Direct transfers to SOEs amounted to 1.6 percent of GDP in FY20/21 compared to an average of 1 percent of GDP in the previous five fiscal years.
  - Stock of government guarantees on SOE borrowing amounted to 10.3 percent GDP in FY20/21, about 2 percent of GDP higher than in FY15/16.
  - Transfers averaging 0.5 percent of GDP per year in FY21/22 and the next two fiscal years have been budgeted.
  - Eskom and energy-sector related guarantees account for 87 percent of the stock of guarantees in FY20/21.
  - Cost to government of direct support through transfers increased from 1 to 1.6 percent of GDP between FY15/16 and FY20/21.
  - Stock of government guarantees on major SOE borrowing picked up from 8 to 10.2 percent of GDP over the same period.
- Financial performance and health:
  - Nonfinancial SOEs have consistently shown cash deficits in 2004–20, averaging about 1.1 percent of GDP per year in aggregate.
  - Nonfinancial SOE debt in 2020 reached 12.1 percent of GDP compared to 2.3 percent in 2004.
  - Financial SOEs contributed about 2 percentage points of GDP to debt accumulation.
  - An SOE health check on 11 nonfinancial SOEs (84 percent of nonfinancial SOE assets) found about 70 percent of fully government-owned SOEs consistently show risk scores above moderate since FY16/17.
  - Partially private-owned SOEs (Telkom and ACSA) had consistently better financial indicators than fully government-owned ones.
- Institutional and governance weaknesses:
  - Lack of an ownership policy; no periodic re-evaluation of SOE objectives.
  - Inconsistent legislative framework (EL, CA, PFMA) with potential contradictions and longstanding lack of PFMA enforcement.
  - Complex and decentralized oversight model creating unclear roles and potential conflicts.
  - Deficiencies in regulatory framework: regulatory uncertainty, limited review of capital projects, insufficient independence of decisionmakers.
  - Governance and oversight concerns contributed to poor financial health and service delivery, exemplified by Eskom.

### International Experience and Policy Options for SOE Reform
- Reform elements associated with success:
  - Favorable political economy environment with credible commitment mechanisms.
  - Conditions for increased competition: liberalize trade, remove barriers to entry, unbundle large SOEs.
  - Increased private-sector participation: broaden ownership structure, use management contracts, staged divestment options.
  - Hardened budget constraints: reduce subsidies, commercialize SOE borrowing, tighten guarantee frameworks.
  - Strengthened regulation: auction monopoly rights, set regulatory rewards and penalties, introduce safeguards for private investors.
  - Collaboration between government and SOE managers: managerial autonomy, performance evaluation systems, professional boards, centralized ownership bodies.
- Policy tools and sequencing:
  - Undertake a comprehensive SOE inventory covering all levels of government and subsidiaries to inform reform strategies.
  - Devise a reform strategy per SOE: transformation into agencies, divestment, liquidation, or retention with reforms as appropriate.
  - Address institutional weaknesses: publish an ownership policy, standardize legislative framework, simplify oversight via centralization (Ministry of Finance or holding company), and enhance disclosure and reporting requirements.
  - Reform retained SOEs: increase competition, broaden ownership, harden budget constraints, reduce regulatory uncertainty, and improve collaboration between government and managers.
- Implementation note:
  - Reforms were often staged over many years tailored to country circumstances.

### Climate, Pandemic Impacts, and the Transition Challenge
- Pandemic macro and sectoral impacts:
  - Overall output contracted by 6.4 percent in 2020 and employment fell by 8.5 percent in 2020.
  - Energy-intensive sector 2020: output decline 13.3 percent; employment decline 7.9 percent.
  - Mining sector 2020: output decline 11.9 percent; employment decline 10.7 percent (coal mining accounts for about 19 percent of sectoral employment).
  - Mpumalanga province: employment dropped by 7.7 percent, with about 1.5 percentage points from mining job losses.
  - Emissions in 2020 may have fallen by 9 to 11 percent from the 2019 level; the pandemic may further reduce emissions by 8 to 10 percent by 2030 below Climate Action Tracker pre-COVID projections.
- Climate and energy context:
  - Over the past decade, over 3.8 million South Africans were affected by natural disasters.
  - Emissions from fuel combustion account for over 70 percent of total GHG emissions.
  - Over 90 percent of electricity generation comes from coal-fueled plants.
  - Mpumalanga is concentrated in coal exposure and hosts most of Eskom’s power plants; Secunda coal-to-liquids operations identified as the largest single-source site of CO2 emissions in the world.
  - South Africa’s 2030 mitigation target range in the updated NDC revised from 398–614 Mt CO2e to 350–420 Mt CO2e.
  - World Economic Forum ranking: South Africa was ranked 110 out of 115 countries on energy systems performance and transition readiness (WEF, 2021).
- Renewable procurement and constraints:
  - REIPPP procured about 9,500 MW since 2011, including 2,583 MW from the latest bidding window announced in August 2021.
  - Average tariffs declined significantly over bidding rounds; renewables became competitive with fossil sources.
  - Grid capacity limitations prevented selection of several competitively priced projects in the latest window.
  - IRP 2019 projects renewables to account for about 36 percent of total installed capacity by 2030; higher shares needed to align with updated NDC.
  - Two REIPPP bidding rounds planned for 2022.
  - Constraints: lack of competition, high regulatory burden, policy uncertainty, infrastructure limitations, Eskom-dominated sector, licensing and third-party transaction barriers, and delayed grid connections.
- Carbon pricing and model scenarios:
  - Carbon tax introduced June 2019; implementation started late-2020 with exemptions and significant tax-free emissions allowances.
  - World Bank (2020) effective tax rate reported as between $0.3–$1.2/tCO2e after allowances.
  - CPAT simulation: CO2 tax progressively increasing to $75 a ton by 2030 (estimated compatible with a 2°C rise).
  - CPAT scenarios differ by generation own-price elasticity:
    - Baseline: generation own-price elasticity 0.7.
    - High-rigidity: generation own-price elasticity 0.2 (reflecting lack of competition and Eskom dominance).
    - Result: under high-rigidity scenario, share of renewable energy by 2030 is less than ½ of that in baseline.
  - Implication: a competitive energy market complements carbon taxes in decarbonizing the power sector.
- Labor market transition impacts and policies:
  - Potential job losses: 452,000 jobs in the coal value chain; 427,000 jobs in the automobile sector due to global EV shift (PwC, 2021).
  - Renewable rollout expected to create jobs but with likely mismatches in location, quality, and skills.
  - Recommended policies: labor market flexibility reforms (collective bargaining, employment protection, minimum wage-setting), education and vocational training improvements, apprenticeships, and active labor market policies including geographical mobility subsidies.
- Governance and justice:
  - Corruption, poor governance, and insufficient accountability risk undermining transition planning and implementation.
  - Governance reforms needed to build stakeholder trust, reduce social resistance, improve coordination, and ensure a fair and just transition.

*Source: excerpts from IMF staff chapters and analyses in 1zafea2022002.*

### 1.   Indicators of Rising Sovereign Risks in South Africa______________________________________ 4

### 1.   Indicators of Rising Sovereign Risks in South Africa

### A. Introduction
- Rising sovereign debt in the wake of the COVID-19 pandemic increased focus on the financial sector-sovereign nexus in South Africa.
- The nexus tightened as financial institutions increased holdings of domestic sovereign debt amid reduced purchases and greater disposals by nonresident investors.
- Direct channel: public debt acquisition by the financial sector. Indirect channels: exposure of financial institutions to domestic economic activity.
- Absent necessary fiscal consolidation and structural reforms, risks from the nexus to both the financial system and the sovereign will increase.
- The paper documents the size of sovereign debt in financial intermediaries’ balance sheets, measures local currency sovereign risk, and surveys literature on fiscal cost of banking crises and recommendations (including those from the 2021 Financial Stability Assessment Program).

### B. Box 1 — Indicators of Rising Sovereign Risks (summary of key indicators)
- Sovereign CDS (external credit risk in US dollar terms):
  - Rose to around 430 basis points in 2015–16.
  - Rose to around 530 basis points in 2020 during COVID-19-related global market turmoil.
  - Trading at around the upper end of the “normal” range relative to its 2010–19 performance (200–300 basis points).
- Sovereign debt-to-GDP ratio:
  - Around 70 percent (reflecting the recent GDP revision).
  - Significantly above previous peak of around 45 percent registered in the 1990s.
- Local currency sovereign term premia:
  - Remains at around its historical high.
- Swap spread (fixed-rate leg of interest rate swap minus maturity-matching sovereign yield):
  - South Africa’s swap spread has been negative.
  - Narrowed from around –370 basis points during worst of COVID-19 market turmoil to around –200 basis points in early-December 2021.
  - Remains wider than previous levels of around –100 basis points and far outside the “normal” range based on historical performance.
- Local Currency Sovereign Risk Premium (LCSRP):
  - Estimated LCSRP is comparable to previous highs including the one registered in 2015–16.
- Actual yield differential to implied counterpart:
  - Moderated from more than 460 basis points in spring of 2000 to around 350 basis points.
  - Remains significantly above previous highs of around 100 basis points and the upper end of the “normal” range of around 70 basis points.
  - Had already widened prior to COVID-19 as the Eskom situation started to worsen.

### C. Importance of Sovereign Debt for Financial Intermediaries’ Balance Sheets
- Reasons banks hold domestic sovereign debt:
  - HQLA eligibility, liquidity requirements, collateral for central bank operations and secured wholesale funding, benchmark for pricing, and income source when other income underperforms.
- Regulatory environment:
  - Basel standards provide national discretion on bank treatment of domestic sovereign debt (risk weights, large exposures, market risk, credit risk mitigation), allowing regulatory incentives.
- Authorities’ policy actions during stress:
  - Liquidity extension to banks, direct purchases of government debt, conditional commitments to purchase government debt by central banks.
  - Financial repression and moral suasion sometimes used to encourage banks to purchase government bonds.
- Drivers of bank holdings across countries:
  - Banks’ bias toward domestic sovereign debt associated with high uncertainty and increasing inflation.
  - Private-sector credit-to-GDP ratio and institutional quality are negatively related to home bias.
  - Banks hold more government debt during periods of high interest rates and in countries with lower private-sector credit-to-GDP ratios.
- South Africa-specific factors:
  - HQLA eligibility of sovereign debt, shortages of other HQLA eligible assets, and phasing out of the SARB’s committed liquidity facility (CLF) provide incentives for banks to hold sovereign debt.
  - The largest six banks on average hold close to 90 percent of HQLA in Level 1 unencumbered assets (mainly domestic government securities and central bank reserves).
  - Largest banks act as primary dealers and market makers in sovereign debt markets.
- Risks:
  - Risks from the nexus increase absent sufficient fiscal consolidation to keep sovereign debt supply in check.
  - Risks also increase if private investment, demand for bank credit, and broader economic activity remain weak.

### D. Government Bond Holdings by Banks and Nonbank Financial Institutions in South Africa
- Historical and recent levels (as reported):
  - Top 6 banks (representing a little over 90 percent of system assets):
    - Holdings of government securities moderated from 6–8 percent of assets in the 1990s to nearly 4 percent in early-2008.
    - Rebounded to around 8 percent of assets by end-2011 (bonds ~60 percent).
    - Rose again from 2017 and reached somewhat above 12 percent of assets by January 2021 (increase driven mainly by bond holdings; bonds’ share rose to 75 percent).
  - Other banks:
    - Marginally moderated to somewhat below 5 percent of assets by early-2008.
    - Rose to nearly 25 percent of assets in January 2021 (increase mainly due to T-bill holdings; T-bills’ share rose to around 70 percent).
  - Nonbank financial institutions:
    - Shed government securities from close to 35 percent of assets in the 1990s to around 15 percent in the 2000s.
    - Ratio rose moderately to 17 percent by mid-2020, due mainly to holdings by “other financial institutions” (OFIs, which include mutual funds and collective investment schemes).
- Cross-country comparisons:
  - South African banks’ government bond holdings as a share of assets were relatively low in early-2000s (near first quartile of 99 countries), moved up to cross-country median in late-2000s, and broadly tracked median increases.
  - As of September 2020:
    - South African bank holdings of government bonds were somewhat below the cross-country median of 129 countries, but above levels in Brazil, Mexico, and Turkey.
    - South African nonbanks were positioned somewhat below the cross-country median of 62 countries, similar to Turkey and above Mexico.

### E. Policy and supervisory observations (summarized)
- Increased focus by the Prudential Authority on associated risks provides reassurance.
- Options to mitigate risks through regulatory measures can be explored (given national discretion under Basel standards).
- Continued emphasis on fiscal consolidation and structural reforms is necessary to limit escalation of risks from the nexus.
- The nexus and potential fiscal cost of banking sector problems underscore the importance of limiting risks, consistent with recommendations surveyed from the 2021 FSAP.

*Prepared by Heiko Hesse (SPR) and Ken Miyajima (AFR); South Africa: The Financial Sector–Sovereign Nexus, January 21, 2022.*

### 11.      Relative to the stock of bonds outstanding, holdings by nonbanks and nonresidents

### 11.      Relative to the stock of bonds outstanding, holdings by nonbanks and nonresidents

### Holdings patterns and recent trends
- South Africa: holdings by nonbanks and nonresidents appear relatively high.
- Banks:
  - South African banks have notably increased their government bond holdings as a share of the total stock during the COVID-19 pandemic, but their holdings still remain below the EME median.
  - IRB banks have been increasing risk weights for sovereign exposure up to 10 percent in line with the rising public debt ratio and weakening sovereign credit ratings.
- Nonbanks:
  - Nonbanks progressively reduced their government bond holdings as a share of the total stock through the early-2010s, but still remain in the top quartile.
- Nonresidents:
  - Nonresident holdings rose from around the median in the early-2000s to the top quartile in the mid-2010s and have remained there even after nonresidents sold government bonds during the COVID-19 pandemic.

### Implications for sovereign and economy funding costs
- A simple correlation analysis suggests banks in South Africa tend to increase holdings of government securities when the yield curve steepens.
- A recent SARB econometric analysis (Makrelov et al., 2021) suggests that higher fiscal risks would prompt banks to increase their capital as a mitigant, making it more expensive to hold such bonds.
- Valuation and volatility risks:
  - South African sovereign bond valuations could become more volatile, potentially increasing the risk of large valuation losses.
  - Such losses could compress profitability and capitalization to the extent that the larger four banks mark to market roughly one half of their government bond holdings.
- Stress-test finding:
  - Widening of external sovereign credit spreads by 200 basis points would lead to a fall in the aggregate capital ratio by some 3 percentage points.
- Funding cost feedback: As banks become more vulnerable or demand compensation for higher risk, banks would demand higher yields to hold sovereign debt, raising sovereign funding costs.

### Channels of spillovers from sovereign to banks
- Exposure channel:
  - Falling sovereign bond prices adversely affect bank holdings and can lead to higher bank wholesale funding costs as collateral value falls.
  - Example estimate: a 10 percent valuation loss on a sovereign bond portfolio (representing 10 percent of the bank’s assets, assuming 6½ percent leverage ratio) would imply a 15 percent reduction in the capital ratio (Dell’Ariccia et al., 2018).
- Safety net channel:
  - Contingent liabilities from government backstops can materialize if fiscal space is limited, feeding into lower bank profits.
  - Sovereign rating downgrades are passed on to bank ratings, increasing bank funding costs.
- Macroeconomic channel:
  - Higher public sector deficits and debt can lead to higher sovereign and domestic interest rates, adversely impacting bank balance sheets.

### Channels of spillbacks from banks to sovereign
- Direct effect:
  - Government intervention to manage a banking crisis converts contingent liabilities into realized liabilities and worsens the debt outlook.
- Indirect effect:
  - Banking-sector developments affect the main drivers of debt (growth, primary balance, and interest rate), potentially deepening recessions and making fiscal cycles more severe when driven by the banking sector.
- Home bias effects:
  - Banks’ home bias in sovereign debt holdings tends to delay fiscal consolidation until debt reaches high levels, providing a captive investor base that can slow necessary fiscal adjustment.
  - Empirical illustration: a relatively high banking sector home bias (relative to the sample median) is associated with a substantially weaker average primary fiscal balance when debt is 80 percent of GDP (compared with sample economies with the same debt level).
  - Context: South Africa’s debt was 70 percent of GDP in 2020, compared with the 80 percent illustrative level.

### Empirical evidence on costs of banking crises and South Africa’s resilience
- Historical international evidence:
  - Median output losses from banking crises: 35 percent of GDP in high-income countries and 14 percent of GDP in low- and middle-income countries.
  - Median increase in public debt in the four years after a banking crisis: a little over 20 percent of GDP in high-income countries and 16–17 percent of GDP in low- and middle-income countries.
  - Examples of extreme fiscal costs: Indonesia’s fiscal costs in the Asian financial crisis exceeded 50 percent of GDP; Iceland and Ireland’s fiscal costs during the global financial crisis exceeded 30 percent of GDP.
- Drivers of higher fiscal costs:
  - Higher bank leverage and reliance on external wholesale funding prior to crises.
  - Full guarantees of bank liabilities can increase direct fiscal costs on average.
  - Higher quality supervision, credible safety nets (e.g., broad deposit insurance), and swifter government intervention tend to lower direct fiscal costs.
- South Africa:
  - Banks have strong capital and liquidity buffers and are well regulated; they have navigated the Global Financial Crisis and the COVID-19 pandemic well.
  - Joint IMF–World Bank FSAP stress tests show resilience to adverse shocks.
  - Nonetheless, rising public-sector fiscal deficits and debt amid increased sovereign risk premia could raise concerns about banks’ large holdings of domestic sovereign debt and expose the system to challenges if macroeconomic difficulties are prolonged.

### Mitigants and policy recommendations
- First line of defense: macroeconomic policies
  - Fiscal consolidation and structural reforms to reduce the supply of sovereign debt, boost medium-term growth, improve banks’ lending opportunities, and strengthen bank capital buffers.
- Strengthen safety nets and resolution frameworks:
  - Finalize the Financial Sector Laws Amendment Bill (FSLAB) to improve the bank resolution framework and introduce a deposit guarantee scheme.
- Carefully calibrated regulatory measures (discussed during the 2021 FSAP mission):
  - Increasing risk weights on sovereign bond holdings:
    - IRB banks have already increased risk weights on domestic sovereign debt holdings.
    - Under national discretion, a (relatively low) risk weight may be applied to domestic sovereign debt denominated and funded in domestic currency, while being mindful of potential pro-cyclical effects.
  - Applying Pillar 1 or 2 capital surcharges:
    - Surcharges could be applied on holdings of domestic sovereign bonds only above certain thresholds, calibrated to reflect perceived risks and discourage excessive concentration while limiting unintended side-effects (e.g., higher cost of meeting liquidity requirements).
  - Introducing a quantitative measure to reduce concentration:
    - Caps on concentration risk could create ‘cliff effects’ if banks rapidly approach limits and consequently shed holdings; this risk must be considered in calibration.
- Implementation principles:
  - Gradual introduction, careful calibration, and clear communication of measures.
  - Consider introducing measures after normalization of COVID-19-related prudential requirements.
  - Provide a reasonable transition period and announce envisaged near-term measures with transition timelines to smooth adjustment and prevent further intensification of the nexus.
- Caution on unintended consequences:
  - Avoid onerous concentration limits or other measures that could be pro-cyclical, excessively reduce liquidity, or pressure bond markets, particularly during sharp economic downturns.
- Complementary actions:
  - Regulatory efforts must be supported by fiscal consolidation to reduce government debt supply and by structural reforms to boost durable growth.

*Source: IMF staff chapter "11. Relative to the stock of bonds outstanding, holdings by nonbanks and nonresidents" (excerpts).*

### 1.      SOEs play a significant role in the South African economy, dominating key network

### 1.      SOEs play a significant role in the South African economy, dominating key network industries

### Role and economic significance
- SOEs are prevalent in the utilities, transportation, and communications sectors as well as the provision of developmental financial services.
- SOEs’ operations are an important determinant of the productivity and the competitiveness of the economy given their varied roles in supplying key inputs for businesses and their significant share in real gross capital formation, averaging 13 percent of total in the last five years.
- As recipients of substantial support from the budget in the form of transfers and guarantees, SOEs create large direct costs and are an important source of fiscal risks in the form of contingent liabilities.

### Fiscal costs, transfers, and guarantees
- Direct transfers from the government to SOEs amounted to 1.6 percent of GDP in FY20/21 compared to an average of 1 percent of GDP in the previous five fiscal years.
- The stock of government guarantees on SOE borrowing amounted to 10.3 percent GDP in FY20/21, about 2 percent of GDP higher than in FY15/16.
- Transfers averaging 0.5 percent of GDP per year in FY21/22 and the next two fiscal years have been budgeted.
- Although a decline in transfers to SOEs is budgeted, there is a high risk that the projected transfers would become insufficient if progress with restructuring plans, especially in the electricity sector, does not accelerate.

### Purpose and scope of the paper
- The paper discusses the South African SOE landscape, international perspective, international experience with SOE reform, and concludes with policy options for reforming SOEs.
- Section B discusses the South African SOE landscape, including general characteristics, the legal and institutional framework, and SOEs’ financial and operational performance.
- Section C puts the South African SOE scene in an international perspective.
- Section D discusses international experience with SOE reform.
- Section E concludes with policy options for reforming SOEs.

### SOE landscape: size, composition, and concentration
- SOEs’ assets amounted to 34 percent of GDP at end FY19/20.
- Nonfinancial SOEs account for 86 percent of total assets while financial SOEs account for the remainder.
- Of the total nonfinancial SOEs, the three largest—Eskom (electricity), Transnet (transportation), and Telkom (communications)—represent about ¾ of assets, 80 percent of revenue, and 97 percent of loan debt (11.4 percent of GDP).
- Of the total financial SOEs, the three largest—the Development Bank of Southern Africa, the Industrial Development Corporation, and the Land Bank—account for 94 percent of assets, 95 percent of revenue, and 91 percent of loan debt (2.8 percent of GDP).
- The utilities sector comprises electricity (Eskom) and water enterprises (water boards and the Transcaledon Tunnel Authority (TCTA)).
- The transport sector comprises mainly Transnet, SAA and SAX (airlines), ACSA and ATNS (airport, air traffic and navigation), and PRASA (passenger railway transportation).
- Other significant nonfinancial SOEs: Telkom, the Central Energy Fund (CEF), and the State Diamond Trader (STD). Smaller companies: SAFCOL, SAPO, Denel.
- In terms of ownership structure of non-financial SOEs, only Telkom and ACSA have private shareholders.

### Institutional and legal framework
- SOEs are created by law and can be established at all levels of government.
- SOEs are subject to enabling legislation (EL), the Companies Act (CA), and the Public Finance Management Act (PFMA).
- EL usually contains a description of SOE objectives and requirements on governance, reporting, and accountability; contents vary across SOEs.
- The CA establishes corporate governance for private sector firms and applies to corporatized SOEs.
- The PFMA defines oversight responsibility for SOEs’ corporate plans, shareholder compacts, and reporting requirements; it also establishes principles regarding the role and responsibilities of SOE boards.
- The protocol of corporate governance is a non-legislated code endorsed by the cabinet; it defines the relationship between government and SOEs while seeking to maintain SOE independence in day-to-day operations.
- SOE objectives are established in enabling legislation, by shareholder departments, and by the cabinet. There is no formal ownership policy nor periodic re-evaluation of the relevance of SOE objectives.
- Shareholder departments are responsible for ensuring SOEs generate appropriate returns on investment and are financially sustainable; cabinet provides policy directives and contributes to SOE objective design and achievement.
- Oversight roles:
  - Parliament’s Standing Committee on Public Accounts reviews annual financial statements and audit reports from the Auditor General.
  - Portfolio committees oversee service delivery performance versus corporate plans.
  - Within the executive, shareholder and policy departments ensure corporate governance and oversee policy implementation respectively.
  - The Finance Minister and the National Treasury are responsible for financial oversight to protect the budget and sovereign credit rating.
  - SOE boards of directors give strategic direction and are accountable for performance; boards are appointed by shareholder departments and must sign shareholder compacts on key performance indicators.
- Regulators interact with SOEs independently when applicable, focusing on pricing issues, consumer protection, and industry standards.
- Accountability mechanisms operate through the executive and parliament; shareholder departments can dismiss SOE boards if performance is unsatisfactory.

### Financial and operational performance of SOEs
- Nonfinancial SOEs have consistently shown cash deficits in the period 2004–20, averaging about 1.1 percent of GDP per year in aggregate.
- Nonfinancial SOE debt in 2020 reached 12.1 percent of GDP compared to 2.3 percent in 2004.
- Financial SOEs contributed about 2 percentage points of GDP to debt accumulation given their much smaller size.
- The Land Bank’s financial position has deteriorated due to decreasing loan quality, requiring budget support.
- An SOE health check methodology was applied to 11 nonfinancial SOEs accounting for an estimated 84 percent of total nonfinancial SOE assets, using financial statements from FY15/16 through FY19/20.
  - The methodology measures profitability (return on assets, cost recovery), solvency (debt to assets, interest coverage), and liquidity (current ratio, quick ratio), and compares to lender/credit rating agency thresholds across five risk categories; a composite indicator estimates overall risk.
  - Interpretation: below-moderate = on track; moderate = gray zone; above-moderate = high or very high risk requiring rectification.
- Main SOE health check findings:
  - SOEs with weak financial performance had consistently poor profitability, liquidity, and solvency indicators, reflected in high indebtedness.
  - About 70 percent of fully government-owned SOEs consistently show risk scores above moderate since FY16/17.
  - SOEs with partial private ownership (Telkom and ACSA) had consistently better financial indicators than fully government-owned ones due to better profitability and solvency.
- Data on government support to major nonfinancial SOEs:
  - Several nonfinancial SOEs (Eskom, SAPO, SABC, Denel, SAA) have received transfers from the budget.
  - Eskom, TCTA, SAA, and Transnet beneficiaries of government guarantees; Eskom and energy-sector related guarantees account for 87 percent of the stock of guarantees in FY20/21.
  - The cost to the government of direct support through transfers increased from 1 to 1.6 percent of GDP between FY15/16 and FY20/21.
  - The stock of government guarantees on major SOE borrowing picked up from 8 to 10.2 percent of GDP over the same period.
- Productivity:
  - Per-employee sales in constant prices had been falling before the pandemic and likely declined further in FY20/21.
  - The decline holds whether sales are measured in rand or in US dollars.

### International comparison and lessons
- Major SOEs operate in similar network industries in other EMEs, but the extent of government ownership is considerably higher in South Africa.
- Internationally, utility companies in other EMEs are often mixed public- and private-owned; 60 percent of utility companies in other EMEs have a mix of public- and private-sector owners.
- Countries like Brazil and China have used private participation to improve incentives for efficiency in SOEs.
- In South Africa, the largest SOEs are typically 100 percent government-owned and some sectors in other countries have private participants with higher productivity.
- Financial SOEs in South Africa focus exclusively on developmental objectives, are modest in size compared to the banking system (4 percent of banking system assets), and do not take deposits from the public—this is a relative strength versus other EMEs where government ownership of commercial banks has been a source of financial sector fragility and contingent liabilities.
- Labor costs:
  - The average cost of labor (as a share of total operating revenues) is somewhat higher in fully government-owned nonfinancial SOEs in South Africa than in majority government-owned entities internationally.
  - In the two South African institutions with minority private shareholders, labor costs are considerably lower than in fully government-owned ones—consistent with evidence that private participation increases efficiency, though the sample of partially private SOEs is small.

### Institutional weaknesses identified (PCRSOE and analysis)
- Key weaknesses documented:
  - Lack of an ownership policy: proliferation of SOEs reflects historical developments rather than a planned long-term vision; no periodic review of relevance or appropriateness; establishing new SOEs is simple with no deep comparative analyses on cost-effectiveness versus alternative means.
  - Inconsistent legislative framework: legislation dispersed among EL, CA, PFMA; important elements may contradict each other (appointment powers, remuneration policy, checks and balances, reporting obligations); lack of enforcement of PFMA provisions is longstanding.
  - Complex and decentralized oversight model: unclear roles create potential conflicts among oversight entities, weakening accountability; National Treasury needs tools to prevent policy ministries from pursuing financially unaffordable SOE policies.
  - Deficiencies in the regulatory framework: regulatory uncertainty, limited review of new capital projects, frequent changes in assessment methodologies, and insufficient independence of key decisionmakers weaken SOE performance; non-viable projects imposed on SOEs can require large tariff increases, raise financing costs, and increase the need for government guarantees.
- Governance and oversight concerns have contributed to feeble financial health and poor service delivery (example: continued deterioration in Eskom’s finances and energy availability).

*Prepared by Alejandro Simone and Zhangrui Wang (AFR).*

### 20.      International experience in addressing the abovementioned challenges can help provide

### 20.      International experience in addressing the abovementioned challenges can help provide 

### International lessons on SOE reform
- Reform success has critically depended on the ability to change the incentives underlying the inefficiency of SOEs.
- A combination of reforms in the following areas has contributed to successful experiences (drawn from World Bank (1995), OECD (2015), and World Bank (2020)):

  - A favorable political economy environment:
    - Three attributes needed: (1) reform must be politically desirable to the leadership and its constituencies—normally achieved after a change in government that weakens the influence of the potential losers or when an economic crisis makes the budgetary burden unaffordable; (2) political leaders act in coordination (legislatures, executive, state or provincial governments) and have the means to implement change, withstand opposition, and compensate losers; and (3) reform announcements are credible to investors and all stakeholders.
    - Three factors helped build credibility: (1) a history of announcing and implementing reforms; (2) domestic commitment mechanisms, such as difficult-to-remove constitutional restrictions on overturning legislation; (3) participation in international agreements or treaties that imply adverse consequences for the government from reversing reforms.

  - Conditions for increased competition:
    - Liberalize trade (e.g., by reducing tariffs and non-tariff barriers).
    - Remove barriers to entry and level the playing field (e.g., removing specific SOE advantages, such as special tax treatments, superior regulatory treatment, and preferential procurement arrangements).
    - Unbundle large SOEs to separate parts that could operate in competitive markets from those that could not.
    - Splitting national monopolies into regional monopolies and allowing companies to bid for monopoly rights can assess firm performance and not renew rights for less efficient firms.

  - Increased private-sector participation:
    - Broaden ownership structure or use management contracts to hire private-sector managerial expertise in open and transparent competitive processes.
    - Examples of approaches taken: retaining majority shareholding with corporate governance reforms (Brazil, China, India, Poland); maintaining minority shareholding after a sale of the majority to the private sector (Brazil, Poland, Spain, UK, Norway); fully divesting companies (Argentina, Brazil, New Zealand).
    - The more competitive the market, the more countries broadened ownership to benefit from private firms’ efficiency advantages.

  - Hardened budget constraints:
    - Explicit or implicit subsidies/transfers/bailouts were significantly reduced or eliminated.
    - SOE borrowing was increasingly made on commercial terms.
    - Guarantee frameworks were tightened to reduce SOE reliance on guarantees to borrow.
    - “Soft loans” from the domestic financial sector were no longer available.
    - Financial sector reforms included strengthened supervision and regulation, relaxation of controls over interest rates, and reduction of directed credit.

  - Strengthened regulation:
    - Regulation should provide incentives to invest, expand services, and operate efficiently while protecting consumers from market power.
    - Achieved by auctioning off the right to be a monopoly in a competitive process or increasing competition by splitting companies into regional monopolies.
    - Set rewards and penalties through regulatory frameworks to induce efficiency and pass gains to consumers through lower prices.
    - Safeguards to protect private producers from government opportunistic behavior were also introduced.

  - Collaboration between the government and SOE managers:
    - SOE managers need freedom, means, and accountability to improve performance (adjust staff levels, seek cheaper suppliers, discontinue loss-making activities, seek new markets).
    - Performance evaluation systems with rewards and penalties directly linked to meeting well-defined objectives.
    - Creation of new centralized ownership and oversight bodies; increased managerial autonomy to limit politicization with expanded powers for SOE managers on pricing, procurement, production, and personnel decisions; performance agreements; upgrades in SOE boards to make them more professional and/or include consumer representatives.
    - Reforms to limit politicization included increasing professional qualifications and strengthening rules against conflicts of interest (Germany, Italy, Singapore, Spain), reducing board sizes (Korea, France, Poland, Spain), and introduction of guidelines for remuneration and employment that apply across SOEs (Czech Republic, Finland, Norway, Sweden).
    - Financial controls on borrowing and guarantee approvals should be retained to limit fiscal risks.

- Reforms were often implemented in stages over many years depending on country-specific circumstances and initial conditions (examples: China starting reforms in the 1970s; Brazil experimenting with different models since the 1980s debt crisis).

### Policy options for SOE sector reform
- Establishment of SOEs is just one policy instrument to address market failures or achieve non-economic objectives; creation of SOEs can have unintended consequences, including inefficient production, facilitation of political patronage and corruption, and a high fiscal cost (Shleifer (1998)).
- Policies to improve SOE efficiency, boost growth, and reduce fiscal risks include:

  - Undertaking a comprehensive SOE inventory:
    - Take stock of existing SOEs at all levels of government (including subnational SOEs and SOE subsidiaries) in terms of commercial viability, relevance of objectives from a public policy perspective, performance, and success in dealing with market failures and achieving non-commercial objectives.
    - An inventory informs reform strategies and fills information gaps.

  - Devising a reform strategy for each SOE (as discussed in Alves (2016)):
    - Transformation into government agencies or budgetary institutions if SOEs are not commercially viable but carry out relevant public policy objectives.
    - Divestment if they are commercially viable but objectives are not relevant from a public policy perspective.
    - Liquidation if they are not commercially viable nor have policy-relevant objectives.
    - Retention as SOEs if they are both commercially viable and have relevant objectives, while pursuing reforms to improve performance.
    - Concentrating on a focused subset of entities to be retained can help upgrade management, improve consumer satisfaction, reduce fiscal costs, and better use scarce monitoring and oversight resources.

  - Addressing weaknesses in the institutional framework:
    - Develop, publish, and periodically review a comprehensive ownership policy (as in France, Finland, Norway, Sweden, and the U.K). An ownership policy states the government’s policy and financial objectives, defines performance indicators, and lays out the organization of the ownership function and governance principles.
    - Standardize the legislative framework across SOEs to eliminate legal uncertainty, strengthen enforcement, and implement increased disclosure and reporting requirements (as in Cyprus, Korea, New Zealand, and the Philippines). An SOE law could define roles and responsibilities of key players (Ministry of Finance, line ministries, and SOE boards), introduce clear requirements for creation/winding down and sale of SOEs, tighten sanctions for non-compliance, and set standardized disclosure and reporting requirements.
    - Simplify the oversight model by increasing centralization of the ownership function (as in China, Denmark, Finland, France, Netherlands, Peru, and Singapore), preferably in the Ministry of Finance or a holding/investment company to unify SOE guidelines and interpretation, compile and report aggregate information, and make the most of scarce expertise.
    - Disclosure and reporting requirements could include: (i) enforcement of international accounting and auditing standards and timeliness of accounts; (ii) publication of key financial and non-financial performance indicators for increased public scrutiny; (iii) quantification and disclosure of the cost of quasi-fiscal operations compared to budget compensation; and (iv) production and disclosure of consolidated information regarding the SOE sector in an annual report to better ascertain the impact of SOE policies on the macroeconomy and public finances.

  - Reforming retained SOEs to improve functionality:
    - Increase competition in markets where SOEs operate.
    - Broaden ownership structure to include private sector participation.
    - Harden budget constraints.
    - Reduce regulatory uncertainty while ensuring price regulation provides appropriate incentives.
    - Make the relationship between government and SOE managers more collaborative.

### Climate and related structural reform context (selected findings relevant to SOE and structural policy)
- Climate risk and decarbonization context for South Africa:
  - Over the past decade, over 3.8 million South Africans were affected by natural disasters, such as droughts, floods, and storms.
  - Emissions from fuel combustion account for over 70 percent of total greenhouse gas (GHG) emissions in South Africa.
  - Over 90 percent of the electricity generation comes from coal-fueled plants.
  - The Mpumalanga region is geographically concentrated in coal exposure and hosts most of Eskom’s power plants; Secunda coal-to-liquids operations are identified as the largest single-source site of CO2 emissions in the world.
  - South Africa’s projected GHG emissions trajectory appeared high compared to targets consistent with the Paris Agreement’s 1.5°C temperature limit, although the government announced a reduction of the 2030 emissions target in its updated Nationally Determined Contribution (NDC).
    - The 2030 mitigation target range was revised from 398–614 Mt CO2e to a range of 350–420 Mt CO2e.
  - The new carbon tax was introduced in June 2019 and came into force in October 2020.
  - South Africa was ranked 110 out of 115 countries by the World Economic Forum on performance of their energy systems and readiness for the transition to a secure, sustainable, affordable, and reliable energy future (WEF, 2021).
  - Several barriers to climate technology adoption: uncertainty and lack of policy and regulatory clarity, insufficient knowledge and information, limited private-sector investment, high costs, social resistance.
  - Need for capacity building for monitoring and assessing climate policies and conducting integrative and systematic climate research (DEFF, 2020).

*Source: 1zafea2022002 - 20. International experience in addressing the abovementioned challenges can help provide*

### 5.       The pandemic has had a significant impact on the carbon-intensive sectors and the

### 5.       The pandemic has had a significant impact on the carbon-intensive sectors and the coal-dependent  region.

### Pandemic impact on output, employment, and emissions
- Overall output contracted by 6.4 percent in 2020 and employment fell by 8.5 percent in 2020.
- Energy-intensive sector outcomes in 2020:
  - Output decline: 13.3 percent.
  - Employment decline: 7.9 percent.
- Mining sector (coal mining accounts for about 19 percent of sectoral employment):
  - Output decline: 11.9 percent.
  - Employment decline: 10.7 percent.
- Mpumalanga province (coal-dependent):
  - Employment dropped by 7.7 percent, of which about 1.5 percentage points reflected job losses in the mining sector.
- Estimated emissions changes:
  - Emissions in 2020 may have fallen by 9 to 11 percent from the 2019 level.
  - The pandemic may further reduce South Africa’s emissions level by 8 to 10 percent by 2030 below the Climate Action Tracker’s pre-COVID projections.

### How the pandemic complicates adaptation and decarbonization
- Public finance constraints:
  - Public debt jumped to nearly 70 percent of GDP in 2020 as the government deployed a policy package to mitigate the pandemic’s impact.
  - SOE exposure to carbon-intensive activities (e.g., coal-fired power plants, fossil fuel transport infrastructure) raises vulnerability to demand drops from decarbonization with potentially significant fiscal implications.
- Labor market characteristics:
  - Gini coefficient: 63 (latest available 2014).
  - Unemployment rate reached nearly 30 percent by end-2019.
  - Close to 1.4 million jobs were lost in net terms in 2020, of which two thirds were low-skilled jobs.
  - Employment fell by over 4 percent during the third quarter of 2021 (partly reflecting July social unrest and looting).
  - Recovery described as "jobless"; medium-term outlook indicates employment could stay below pre-pandemic levels for a protracted period.
- Trade-offs in the recovery plan:
  - Economic Recovery and Reconstruction Plan prioritizes greening but includes measures that may be incompatible with a low-carbon rebound.
  - Under RMIPPP, most of the 2 gigawatts of energy procured use carbon-intensive gas technology, with 20-year power procurement agreements potentially locking in high-carbon generation.
  - Draft Mining and Energy Recovery Plan focused on investing in high-carbon sectors such as gas without due concern for low-carbon technologies.

### Advancing structural reforms in support of climate objectives
- Decarbonization of the power sector is central; policy tools include a carbon tax and REIPPP.
- REIPPP achievements and limits:
  - About 9,500 MW of capacity procured since 2011, including 2,583 MW from the latest bidding window announced in August 2021.
  - Average tariffs declined significantly over bidding rounds, with renewable prices becoming competitive with fossil sources.
  - Grid capacity limitations prevented selection of several competitively priced projects in the latest bidding window.
  - Risk to Integrated Resource Plan (IRP 2019): renewables expected to account for about 36 percent of total installed capacity by 2030; higher shares needed to align with the updated NDC.
  - Two REIPPP bidding rounds planned for 2022 (as noted).
- Constraints on renewable rollout:
  - Lack of competition, high regulatory burden, policy uncertainty, and infrastructure limitations delayed procurement (latest bidding window took almost 6 years to open).
  - Power sector concentration dominated by Eskom; entry barriers include stringent licensing requirements and restrictions on third-party transactions.
  - Delays in connecting procured renewable projects to the grid; underinvestment in transmission due to Eskom’s financial difficulties.
- Recent regulatory changes:
  - Amendments to the Electricity Regulation Act lowered licensing requirements and eased electricity supply restrictions, but further regulatory clarity is needed (e.g., rules governing electricity sales and registration).
- Reforming Eskom:
  - Eskom’s outdated business model favors large-scale coal and nuclear projects, resists new entrants, and contributed to underinvestment in the transmission grid.
  - Eskom announced a Just Energy Transition Plan seeking concessional financing for decommissioning coal plants, increasing renewables share, and strengthening the grid.
  - Access to green finance contingent on demonstrating commitment to private sector-led renewable production and full operational overhaul of Eskom; otherwise financing could entrench unsustainable operations.
  - Policy prescription: enabling regulatory environment with clear rules, fostering competition and private-sector participation, complemented by concessional financing and reduced Eskom footprint.

### Carbon pricing, market structure, and model scenarios
- Carbon tax:
  - Introduced in June 2019; implementation started late-2020 with exemptions and significant tax-free emissions allowances.
  - World Bank (2020) effective tax rate reported as between $0.3–$1.2/tCO2e after allowances.
  - CPAT model simulation considered a CO2 tax progressively increasing to $75 a ton by 2030 (estimated compatible with a 2°C rise).
- IMF Carbon Pricing Assessment Tool (CPAT) analysis:
  - CPAT is a reduced-form energy consumption model incorporating growth forecasts, elasticities, technical progress, and price changes.
  - Two scenarios analyzed differing by power-sector rigidities (proxied by generation cost elasticities):
    - Baseline scenario uses a generation own-price elasticity of 0.7.
    - High-rigidity scenario uses a generation own-price elasticity of 0.2 (reflecting lack of competition and Eskom dominance).
  - Key result: under the high-rigidity scenario, the share of renewable energy by 2030 is less than ½ of that in the baseline scenario.
  - The implication is that a competitive energy market greatly complements carbon taxes in decarbonizing the power sector.

### Labor market transition and social implications
- Job displacement estimates:
  - 452,000 jobs in the coal value chain could be affected by the transition.
  - 427,000 jobs in the automobile sector could be lost due to the global shift toward electric vehicles (PwC, 2021).
  - Renewable rollout expected to create more jobs, but mismatches likely in location, quality, and skills.
- Policy measures to support displaced workers:
  - Promote labor market flexibility via reforms in collective bargaining, employment protection legislation, and minimum wage-setting to give firms greater workforce management ability and boost opportunities for inexperienced and young workers.
  - Improve education quality, apprenticeships, and vocational training to tackle high structural unemployment and support reskilling/upskilling.
  - Improve active labor market policies, particularly geographical mobility subsidies, to bridge spatial divides between displaced workers’ locations and where new jobs are created.
  - These measures are especially important given pandemic impacts on the young and low-skilled.

### Governance and justice in the transition
- Governance vulnerabilities:
  - Concerns about corruption, poor governance, and insufficient accountability and transparency can undermine planning, management, and implementation of climate resilience transitions.
- Need for governance reforms:
  - Accelerating governance reforms will build stakeholder trust, reduce social resistance, and improve coordination across ministries and government levels.
  - Improved governance will reduce policy uncertainty and promote efficient use of resources to ensure a fair and just transition that benefits affected regions and communities.

*Source: International Monetary Fund (chapter content).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1zafea2022002.pdf_