The Prescribed Asset Debate: Why is the Topic on the Table?
South Africa has a debt problem. A serious one.
If the country was an individual, it would resemble that guy who is trying to pay his credit card debt by maxing another credit card.
Magnus Heystek, director at Brenthurst Wealth Management, has, for some time, warned of a “financial tsunami” that is going to hit South Africa. He has stated recently, that this tsunami is no longer approaching; it is here.
According to Kevin Lings, chief economist at STANLIB, government is currently effectively borrowing R1 billion a day. Of course, it does not really borrow daily, rather in tranches, but if that is spread over the amount of days and total amount borrowed, it equates to a billion rand per day over and above tax revenue. “Saturday and Sundays included,” says Lings.
This would not be problematic if you could see the billion rand at work when you stick your nose out the door: roads being built, dams constructed… infrastructure projects blooming everywhere. “The fact that you are not seeing this, shows that the billion per day is being borrowed to pay ongoing expenses,” says Lings, like salaries and social grants. “This is not sustainable,” he says.
In his speech at the inaugural Sustainable Infrastructure Development Symposium South Africa held on 23 June, president Cyril Ramaphosa confirmed that infrastructure will be placed at the centre of the stimulus that the economy needs for a sustainable recovery, post Covid-19.
At the symposium the government confirmed that it is currently evaluating 276 projects with an investment value of R2.3 trillion. The possible job creation is pitched at 1.8 million, but a funding gap of R502 billion needs to be bridged to bring this to fruition.
In policy documents and discussions over the last year or so the ruling party, as well as government, has been making mention of possibly introducing a mechanism that would allow a greater portion of retirement savings to flow directly into infrastructure (see our first article in the series here). Clarity around what exactly is envisioned is still not contained in actual regulations or policy documents, with one side of the spectrum of stakeholders fearing it is the first step to taking control over private sector funds for government use, and other side indicating the positive opportunities unlocked by allowing funds to diversify into infrastructure investment.
Victoria Reuvers, managing director of Morningstar Investment Management SA, says the country finds itself in a situation that is a function of its low-growth environment. The country’s debt and its interest rate have steadily been increasing in parallel. Finding the funds on the international market is proving too expensive for a country that has faced several ratings downgrades over the last couple of years.
“If we can borrow money more cheaply, we can potentially grow ourselves out of this debt problem,” Reuvers says.
Lings is of the opinion that the money for these projects is available, not only in the approximately R4 trillion that is locked up in pension fund savings locally (which the government seems to be eyeing). It is also locked up within discretionary funds held in the private sector, where there are investors who would be willing to fund well-scoped and appropriately managed infrastructure projects. If Enoch Godongwana’s envisaged tweak of Regulation 28 could unlock this pool of funds.
“In order for that money to be unlocked, there needs to be a high level of confidence that the projects that government intends to undertake are appropriate, scoped correctly, financed correctly in terms of who does the contract and in the oversight of the project. There needs to be steps taken to ensure that the project is not mired in corruption. If those factors were to be put in place, then I think there would be more than enough money to fund this,” says Lings.
“So, what you have is a government that is desperate to grow the economy but has no money. You have a private sector that has money but is lacking confidence. That is what you’ve got if you break it all down,” says Lings.
The bandying about of prescribed assets as a possible avenue to gain funding is doing even more harm to the confidence levels, says Heystek. In an opinion piece published on his company’s website he says that ANC policies such as Expropriation Without Compensation (EWC) and the suggestion of prescribed assets on pension funds has “shattered whatever confidence was left”.
Where will the money come from?
There seems to be general consensus that the correct infrastructure projects could be the country’s ticket out of the recession its facing. A ticket on a slow, albeit steady, train back to growth.
Not all commentators are against the idea of encouraging pension funds to invest in these projects.
Max du Preez, South African journalist, author and political analyst, says that, of late, he is seeing a far bigger openness to entertaining this idea in the private sector. He quotes Piet Mouton, CEO of PSG who was interviewed in the Sunday Times and stated that prescribed assets are an interesting place to look for the money to fill the massive hole that exists in tax collections. “Because I don’t know where else you can go,” Mouton was quoted as saying.
“If we can invest somehow directly into some of these huge infrastructure projects, it would be good for the pension funds, it would be good for the economy, it would be good for stability,” Du Preez says.
“If government can raise funding at a lower cost and use that funding correctly through infrastructure projects, what that does is it creates jobs, it decreases unemployment, it increases tax revenues and decreases debt. Emphasis must be placed on whether the funding is used correctly. If this can be achieved, the net effect is positive for the economy and positive socially. Then it can be to the benefit of South Africa,” she says.
Can it work?
In any economy the government has to consider multiple sources of finance. South Africa’s finances are currently under enormous pressure. “The longer the economy remains weak, the pressure on government finances will continue to escalate,” says Lings.
For a government that ideologically wants to remain at the centre of steering growth, which Lings believes the South African government is leaning towards, the options are somewhat limited.
They can increase taxes, but it is at a point where it would be counterproductive as it would hurt the economy more than it would benefit it and could also lead to tax avoidance. The second option is to approach organisations such as the International Monetary Fund (IMF) and the World Bank, which historically is not necessarily the government’s favourite course of action. Government has indeed now approached the IMF for US$4.2 billion for a Covid-19 response loan. The third option, says Lings, is to see if they could move money from the private sector pool of funds to where it can be utilised for government projects.
This third option is where prescribed assets, direct investment into infrastructure by pension funds and a possible change to Regulation 28 of the Pension Fund Act, become debated options.
“On the face of it, there is merit in the argument,” says Lings. “It is conceivable that pension money could be used more effectively to create broader impact for the economy. The concept is clear, but the devil is in the detail in terms of execution.”
The Democratic Alliance’s Shadow Minister of Finance, Geordin Hill-Lewis, says that his party is worried that the government could make the channelling of funds towards government control “mandatory by stealth”, where the regulation is formed in such a way that it does not leave much scope or choice for alternatives.
What is definitely clear is that a careful approach is required, otherwise the process will have unintended consequences.
“If government makes this voluntary, but it is perceived by the market as forced, then investors will behave as if it is a forced investment,” says Lings. The funds would therefore not flow towards infrastructure to the extent that the government had hoped for. Eventually this could lead to a situation where the government then has to take the next step and make it mandatory.
Swaying the sceptics might prove difficult. What can the government put in place to reassure the public that its intentions are good?
“One of the biggest problems is the lack of trust in the government,” says Du Preez. “People are allergic to go into business with government. And it is unfortunately not an unrealistic fear if you look at the track record we are faced with.”
Reuvers states that the institutions in control of the financial sector (Treasury and the Reserve Bank) has proven to be very strong against political influence.
“At this moment people can feel safe with their investments in retirement products. The Pension Fund Act has been carefully considered and the financial institutions in our country is incredibly robust, headed by people of gravitas,” she says. Still, Reuvers admits, what the public needs is evidence of government acting appropriately. “I don’t think they want to see a plan. They want to see evidence of government showing good practice and solid management of public-private partnerships. That would create confidence that if prescription was in indeed put in place, at least the money will be spent well.”
Evidence for the public could also come in the form of legislation. “The question would be to what extent government would consider making it abundantly clear that this will remain voluntary, for example by legislating this voluntary status. If they don’t, a high degree of scepticism will remain and thus have the danger of these unintended consequences attached to it,” says Lings?
Sound familiar? This article was first published on Daily Maverick, 2 October, 2020.