Designing a Better Financial Shock Absorber to Improve Risk Management of South Africa’s Debt Portfolio

September 22, 2016


Strengthening shock absorbing mechanisms, like the thick bumpers on these fairground car rides, will help South Africa’s treasury better manage risk when it comes to debt

Snap2Art / Alamy Stock Photo

  • South Africa is in a better position to absorb fiscal shocks thanks to improved risk management of the country’s public debt portfolio.
  • A partnership between the World Bank and the Government of South Africa has produced new benchmarks based on customized model that analyzes the cost and risk factors in the country’s debt portfolio.
  • These benchmarks are in line with international practice, allowing the National Treasury to increase its credibility and accountability.

PRETORIASeptember 22, 2016 – South Africa has made significant progress to improve the financial risk management of its public debt portfolio thanks to a tailor-made model designed to analyze the costs and risk factors. This tool, developed through a partnership between the Government of South Africa and the World Bank Treasury, allows the country to be better positioned to absorb fiscal shocks going forward.

Emerging market economies, of which South Africa is one, became a viable outlet for investors who flooded these markets with capital in the aftermath of the global economic crisis of 2008, when the gross domestic products of advanced economies fell by 3.4%. But in the last three years, growing volatility in emerging countries has led to vast outflows from emerging market countries to other currencies and investment options.

Eight years after the global crisis hit, the South African economy, along with many other economies in the world, continues to struggle for a sustained recovery. Although developing economies have fared better, short to medium term prospects remain uncertain,” noted Lungisa Fuzile, Director General of South Africa’s National Treasury.

A fiscally conservative upper-middle-income country, South Africa borrows 90%of its public debt in local currency from its well-developed domestic market. However, more than one-third of this domestic market debt actually comes from foreign investors, exposing South Africa to financial risks and capital fluctuations, making it necessary to create a better shock absorber.

In order to mitigate its financial risks, South Africa partnered with the Government Debt and Risk Management (GDRM) program, a World Bank Treasury initiative sponsored by the Swiss State Secretariat for Economic Affairs (SECO), to develop better benchmarks for managing South Africa’s risk exposure and find a more suitable modeling tool to analyze the cost and risk factors in their debt portfolio. The joint team developed a powerful tailor-made medium-term model to conduct “what if” scenarios to analyze the cost and risk trade-offs of alternative strategies under different shock scenarios. South African authorities have used the output of the model to select a new set of benchmarks since 2014.

The benchmarks should also be seen as a communication tool. A well-chosen set of strategic benchmarks conveys key dimensions of the debt portfolio in a succinct way,” said Çiğdem Aslan, Lead Financial Officer for Public Debt Management at the World Bank Treasury.

There are multiple benefits to defining and following strategic benchmarks. They help the government clarify cost and risk preferences, promote transparency, and systematize the analysis process. Furthermore, strategic benchmarks add structure to the operational side of debt management. For instance, when decisions are made such as determining the term of a government bond, they must be within the range defined by the strategic benchmarks.

Using the right model, the joint South Africa National Treasury and World Bank GDRM Program team revised and built upon previous benchmarks to make the country’s risk exposure more resilient to financial shocks. While South Africa was capturing exchange rate and interest rate risks, some benchmarks needed further clarity and separate indicators for inflation and refinancing risks. They developed a more suitable modeling tool for running different debt and risk exposure scenarios to arrive at the right numbers. Separate benchmarks linked to limits or ranges were created to assess the share of treasury bills (T-bills), fixed rate bonds, inflation linked bonds (ILBs), and the average time to maturity for nominal bonds and ILBs.

Establishing a new system, like these benchmarks, takes time. Different stakeholders challenge the system however with each new iteration, ownership and implementation become easier,” explained Sebastien Dessus, World Bank Program Leader for South Africa.

The new benchmarks are in line with international practice, allowing increased credibility and accountability for the National Treasury. Despite market volatility, South Africa has stayed within their benchmark ranges during the last three years. The partnership with the World Bank continues with further support on assessing credit risk stemming from government guarantees.