Funding the Deficit?

In association with Nedbank.

Namibia’s fiscal challenges have been well documented, with Government running large deficits for the better part of this last decade. The extent of the revenue-expenditure mismatch has seen total public debt balloon from around N$16 billion in 2010 to over N$90 billion by the end of 2019.

While some of this debt is issued in foreign currency, such as the two Eurobonds (issued in 2011 and 2015, maturing soon) and the JSE-listed debt programs, the majority of our debt is issued domestically. The issuance of public debt is typically handled through the Bank of Namibia. Regular auctions are held across the variety of debt instruments issued by Government, such as treasury bills and bonds.

There are usually enough buyers for this debt; the pension funds are particularly active buyers. Relatively strong demand for Namibian public debt was seen for most of last year, which can be attributed to the change in pension fund regulations. With the promulgation of Regulation 13, Namibian pension funds had to increase their holdings of Namibian assets to 45% of their total assets. Namibia’s investable universe is relatively small and illiquid, resulting in much of the pension fund inflows finding a home in government debt. However, as more pension funds became compliant, demand in government debt auctions started drying up. At the time of writing, Government had raised N$973.6 million less than it had planned to.

Since the start of 2020, Government’s debt auctions have seen increasing under-subscription. In other words, there are fewer and fewer buyers meaning Government does not raise the full amount it wants to issue. Most pension funds are compliant with Regulation 13, meaning there will be no more transitory flows or ‘artificial’ demand for domestic public debt.

However, Government will need to continue issuing large volumes of debt to fund its operations. The shortfalls from the auctions in 2019/20 will be rolled over into the 2020/21 financial year and form part of those auctions. Additionally, there are severe risks to expenditure slippage. The COVID-19 outbreak will require Government channeling funds to healthcare, none of which has been budgeted for. There will also be severe economic consequences, as we expect to see increased pressure for bailouts from SOEs such as Air Namibia, the Namibia Airports Company and Namibia Wildlife Resorts as tourism comes to a halt amidst the virus outbreak. These will see Government run a larger deficit than the planned N$7.1 billion for FY2020/21. The impact of events like lockdowns will also have a direct impact on government’s tax revenue, as employees and companies will have reduced incomes. Reduced incomes will also lead to less consumption activity, meaning a likely VAT shortfall as well.

The impact of COVID-19 will go further, however. Most major economies are slowing down, with deep contractions anticipated in the US and Germany. Namibia will not escape unscathed – we have no buffers to withstand external shocks. It appears that Namibia may well face another contraction this year, this time the result of external factors. There will be pressure on Government to provide some relief, not just to SOEs, but to the wider economy. This is especially so as unemployment looks likely to increase – starting with the tourism sector but spreading further as the economy slows and measures to stop the spread of the virus are introduced.

The public debt trajectory is unsustainable as is. Despite this, it appears that there will be little choice but to issue more debt. There are several avenues for issuing more debt. The first is to pay up for debt – issuing it at rates more favourable to investors, thereby making it more attractive and theoretically increasing demand. Not only do we increase the quantum of debt, but the cost at which this new debt is issued. Another option is to again pull the Regulation 13 lever; however this restricts the ability of pension funds to seek the best returns for their clients who will one day need to live off their investments. Furthermore, once the pension funds are compliant we are back at square one.

On the upside, global interest rates are decreasing while central banks are boosting liquidity – meaning there should be plenty of money looking for a home with a good, positive return (the bonds of several major economies have negative rates). A potential solution lies here: providing a mechanism for foreign buyers of our domestic issued (i.e. NAD denominated) debt. One such option is the Newfunds S&P Namibia Bond ETF, currently listed on the JSE. However, we can go further. The largest limitation is that the current settlement system for this debt is paper based, making it a hassle for foreigners to participate in the auction. An effort to get the system up-to-date forms part of the FIM Bill, but this has not yet made it through Parliament. This is no silver bullet, but it does go some way in alleviating a developing problem, and would go a long way in helping us fund what will, in all likelihood, be a much larger budget deficit.