Breaking from 26 years of reticence, South Africa has decided to apply for a loan from the International Monetary Fund (IMF), the mashonisa (lender) of international finance. The hook, an apparently innocuous loan that has an interest rate of 1% and few conditions, will result in the gradual loss of monetary sovereignty.
The loan will pave the way for South Africa to get into the clutches of an organisation that has a controversial track record of lending to developing countries over the past four decades. It will also provide political cover for South African elites to force through structural reforms in the face of the country’s worst depression in a century and growing domestic and international resistance towards neoliberal economics.
According to Fadel Kaboub, a modern monetary theory economist, a monetary sovereign country is one that issues its own currency, taxes the people in its own currency, issues debt in its own currency and has a floating exchange rate that is not fixed against another currency. Technically, such a country cannot default on its debt. It can also pursue its economic development objectives without worrying too much about the reactions of international investors. Modern monetary theory is an increasingly popular school of economic thought that has been embraced by many democratic socialists in the United States.
South Africa comes close to meeting all four conditions. It has the unique privilege among developing countries of having 90% of its sovereign debt denominated in rands. It also has deep capital markets that were worth R20.7 trillion – four times the size of its R5.1 trillion economy – at the end of December 2019, according to the Reserve Bank. The shares on the JSE stock exchange were worth R17.4 trillion. The government and corporate debt instruments that trade on the bond market were worth R3.3 trillion.
Origins of the IMF
The IMF was established in 1944 as Allied leaders drafted plans for a post-World War II economic order at the Bretton Woods Conference in the US. They set up a system of fixed exchange rates that were linked to the US dollar. The IMF, which supervised the system, had a mandate to promote international cooperation, support the expansion of trade and discourage policies that would harm prosperity.
The IMF began operations in March 1947 with 40 members, including three African countries: South Africa, Egypt and Ethiopia. It helped members who had problems with their balance of payments, a statement that records a country’s financial transactions with the rest of the world.
The balance of payments has two components. The current account measures trade, unilateral transfers (remittances and donations) and other receipts and payments (interest, rent and profits). The capital account measures loans, foreign direct investment, portfolio flows (the purchases of shares and bonds) and changes in foreign exchange reserves. Under fixed exchange rates, countries frequently depleted their foreign exchange reserves after selling them to buy national currencies and defend their values against the dollar.
During the Cold War, from the 1950s, communist countries withdrew from the IMF. But many newly independent African countries joined the fund. Although it had been established to assist developed countries, the IMF’s focus changed from the 1960s as more lending went to developing countries.
The Bretton Woods system of fixed exchange rates collapsed in 1973. The IMF’s mandate was reduced in the new era of floating exchange rates. Its original raison d’être was gone, says IMF historian James Vreeland. If a country’s exchange rate depreciated, there would, in theory, be no need to sell foreign exchange reserves to buy the national currency and prop up its value. As it searched for a new purpose, the fund began to direct almost all its resources to developing countries, many of which continued to have fixed or managed exchange rates.
The first crisis
The first developing-country crisis happened in Mexico in 1982. Since then, every developing-country currency crisis – including Mexico (1994), East Asia (1997), Russia (1998), Brazil (1999), Argentina (2002 and 2018) and Turkey (2018) – has been because of a loss of monetary sovereignty following the accumulation of foreign currency loans. Ahead of each crisis, there was an increase in portfolio inflows as countries liberalised their capital accounts, reducing restrictions on the flow of money into and out of their economies as the IMF had advised. Sudden stops of these volatile flows of “hot money” triggered numerous crises.
Each time, the IMF has been accused of pouring oil on the flames of a crisis, behaving like the collection committee of international creditors and bailing out the banks and not the people of the affected countries. It financed dictators such as Mobutu Sese Seko in the Democratic Republic of the Congo, Ferdinand Marcos in the Philippines, Suharto in Indonesia and Augusto Pinochet in Chile, writes Mae Buenaventura, deputy director of the Asian Peoples’ Movement on Debt and Development.
After Mexico defaulted on its debt in 1982 as a result of soaring interest rates in the US, the crisis spread to more than 40 developing countries in Latin America and Africa, which had also taken dollar-denominated loans, according to a paper by economists Jeffrey Sachs and Harry Huizinga.
In exchange for loans, the IMF forced countries to implement structural adjustment programmes – free-market policies such as austerity, privatisation and liberalisation, which later became known as the Washington Consensus. These one-size-fits-all policies, which did not take into account local conditions, exacerbated the crisis and undermined democratic governance.
The IMF refused to support debt relief, which was eventually implemented by the US in 1989. In Latin America, the crisis resulted in a lost decade – La Década Perdida. José Antonio Ocampo, a Columbia University economist and former Colombian finance minister, says the crisis was “the most traumatic event in Latin American history”.
Stephen Lewis, a former United Nations envoy for HIV and Aids in Africa, said IMF loan conditions had contributed towards the spread of the epidemic on the continent. About Zambia, he said: “The ministry of health can hire no more staff, and fully 20% of municipal districts have no doctors and no nurses. The IMF has failed to grasp the demonic force of the human and economic carnage caused by HIV and Aids.”
In Russia, the IMF was involved in developing disastrous “shock therapy” policies – a big-bang transition from communism to capitalism, which resulted in hyperinflation throughout 15 former Soviet Bloc countries and a 40% decline in Russia’s gross domestic product (GDP), the value of all goods and services in the economy, between 1990 and 1998.
In East Asia, economist Joseph Stiglitz was scathing about the IMF’s interventions in the wake of a currency crisis that started in Thailand in July 1997 before spreading to other countries in the region. The crisis was owing to a simple panic in a region that had fixed exchange rates. But the IMF’s medicine, telling countries that had healthy budget surpluses to tighten their belts, killed the patient, he said. Economist Caroline Lee says South Korea did not have a budget deficit problem. But the IMF ordered the country to increase taxes, make budget cuts, allow bank failures and implement structural reforms that had nothing to do with the crisis.
Over the next decade, many developing countries shunned the IMF. This was partly because of the stigma the organisation acquired during the Asian crisis, according to economic historian Adam Tooze. In Asia, many countries accumulated foreign exchange reserves to prevent a repeat of the crisis. By 2007, the IMF’s outstanding loans had shrunk to just $11.1 billion, Tooze says. But in the wake of the global financial crisis, the IMF expanded its activities. During 2009, the IMF said it had tripled its lending capacity to $750 billion.
It also announced the issue of a new special drawing right (SDR) that was worth $250 billion. An SDR is a virtual international reserve currency that is issued by the IMF. One SDR is worth $1.38. Allocations are made according to a country’s IMF quota, which is calculated according to a number of criteria, the most important of which is GDP. Quotas determine the subscriptions a country must make to the IMF and what it can borrow from the fund. Countries use SDRs to supplement their foreign exchange reserves.
Stuck on repeat
In recent years, the IMF has made concessions. It started talking about country ownership of reform programmes, poverty reduction and consultation with civil society. In 2012, it admitted that the costs of austerity were much larger than it had previously calculated. It also said that countries could use capital controls, but only as a last resort. However, despite the new rhetoric, the IMF always pivots back to what Lara Merling, a researcher at the International Trade Union Confederation says is the “old playbook of austerity and deregulation”. Yanis Varoufakis, a former finance minister of Greece, has accused the troika – the IMF, the European Central Bank and the European Commission – of thuggery, fiscally waterboarding the country between 2010 and 2014 and causing an unnecessary great depression.
Debates about whether to close or reform the IMF have continued for decades. At the top of the reform agenda is the need to make changes to the IMF’s governance and undemocratic quota system, which results in an under-representation of developing countries. Important IMF decisions require an 85% majority, which gives the US, with a quota of 16.73%, an effective veto. Sachs says the IMF is “a convenient instrument of United States financial diplomacy”. China, with a contribution to world GDP of 15.5%, has a quota of 6.16%.
The next issue is the IMF’s financial resources. Ahead of the Bretton Woods Conference, according to Vreeland, there were two plans. John Maynard Keynes, the great British economist, proposed an international clearing union, which would have required $26 billion. US Treasury economist Harry Dexter White proposed a stabilisation fund, which would have required $5 billion. The final agreement resembled the US plan. As a result, the IMF’s resources were not enough to stabilise European economies and exchange rates after the war. Rather than expand the IMF, the US decided to assist directly with the Marshall Plan, which received $13 billion. “The IMF was essentially dealt out of the process of the rebuilding of Europe after World War II,” Vreeland says.
Today, the IMF does not have the resources to rebuild the world economy after the economic devastation of Covid-19. The world economy will contract by 5.2% during 2020, according to the World Bank. Although the IMF says it has mobilised lending capacity of $1 trillion, Edwin Truman, a researcher at the Peterson Institute for International Economics, a Washington think-tank, says: “The fund’s capacity for new lending at maximum is $787 billion.” This is equivalent to 0.9% of world GDP, or 27% of the US’s $2.9 trillion stimulus.
The IMF has pledged emergency financing of $100 billion to assist developing countries in the wake of the Covid-19 crisis. By 23 June, it had approved $64.8 billion for 73 countries, with the bulk ($23.9 billion or 37%) having gone to Chile. For most other countries, the emergency loans are relatively small. A proposal is that the IMF could issue new SDRs worth $500 billion. But this bitcoin solution to world poverty will not make a difference. Ocampo says such an issue would be worth 0.7% of GDP for Latin America and add 5% to each country’s reserves. In South Africa, it would result in an increase in reserves of R55 billion, equivalent to 6% of total reserves and 1.1% of GDP. The country does not need more foreign exchange reserves. The IMF is like a stokvel that cannot help you when the going gets tough.
South Africa is a sovereign state which issues its own currency. Therefore, it cannot fail to meet its own obligations in its own currency unless it chooses to do so. In other words, it cannot exhaust its domestic resources. SA Inc has a vast balance sheet that includes assets within the Public Investment Corporation worth R1.9 trillion and R264 billion in cash balances. The IMF helps countries that have problems with their balance of payments. South Africa does not have a problem with its external payments. It has foreign exchange reserves of R922 billion. The reserves are equivalent to eight months’ imports compared with an international benchmark of three months. The country has deep capital markets that finance government expenditure.
The proposed IMF loan is worth $4.2 billion (about R73 billion). Given the small sizes of the loans given to other countries, it is not certain that South Africa will get the whole allocation, which could require that it applies for normal funding windows with their strict conditions. If South Africa gets the allocation, it will be equivalent to 1.4% of GDP. It will finance less than 10% of this year’s budget deficit, let alone the R1 trillion fiscal stimulus that is required to reduce the impact of Covid-19 and finance a recovery. The true cost of the loan must take into account the cost of the depreciation of the rand, one of the world’s most volatile currencies.
Short walk to hell
Once a country commits what economists refer to as the “original sin” of borrowing in foreign currency, the walk to hell is short. The nightmare of managing currency mismatches, where sovereign assets and incomes fluctuate owing to exchange rate movements, plays havoc with macroeconomic policies, especially in developing countries. Foreign currency borrowing is associated with increases in financial fragility and the frequency of financial crises. It has been responsible for virtually all emerging market crises over the past four decades.
The first loan from the mashonisa always looks harmless. But it is never the last one. It sets off a cycle of increasing debt dependency. According to Misheck Mutize, a finance lecturer at the University of Cape Town, of the countries across the world that have been bailed out by the IMF, “11 have gone on to rely on IMF aid for 30 years; 32 have been borrowers for between 20 and 29 years; and 41 have been using IMF aid for between 10 and 19 years. This shows how impossible it is for a country to wean itself off an IMF programme.”
The road to salvation for South Africa is to increase its monetary sovereignty. This will require measures to significantly reduce foreign ownership in the country’s capital markets. At the end of May 2020, foreigners owned 39% of the shares on the JSE and 31.5% of government bonds. There are many large listings of companies that have no South African assets, which distort the JSE. The government should ban these listings. “Monetary sovereign countries have no need to go to the IMF,” says Ndongo Samba Sylla, a development economist.
If the IMF cannot provide the resources to finance a Covid-19 stimulus and recovery package, why is the government pursuing this route? There is a view that the loan is not about money. It is about politics and the need to prepare the country for a fully fledged IMF programme. “The loan is about policy capture, to tie the country to a neoliberal trajectory. If new people are in charge of the ANC or the government, they will have to continue implementing the IMF programme,” says Chris Malikane, an economics professor at the University of the Witwatersrand.