03/03/20

Finance Flows

In association with Nedbank.

At the end of 2019, Namibia’s foreign currency reserves totalled approximately N$28.8 billion – meaning the estimated import coverage fell to 4.16 months. Why are the import coverage and foreign reserve levels often reported? What makes them so important? In brief, they measure how long we can continue to import from the rest of the world if we were to stop generating foreign currency earnings. The foreign reserve levels also help us guarantee the 1:1 peg with South Africa’s rand.

How, then, do these reserves increase? Alternatively, what leads to them being drained? 

To answer this question, we need to analyse Namibia’s Balance of Payments figures as these illustrate the nation’s transactions with the rest of world. The Balance of Payments, as defined by the International Monetary Fund, is a statement that summarises transactions between residents of one nation and non-residents during a specified period. In our case, between Namibians (including Namibian companies) and the rest of the world. It consists of three main accounts: the Capital Account, the Current Account and the Financial Account.

To simplify it: Current Account + Capital Account + Financial Account = Change in Reserves.

The balance on the Capital Account shows the total credits less debits for capital transfers and non-produced, non-financial assets. These are essentially things like rights over mineral resources, electromagnetic spectrum (e.g. for cellphone service providers), contracts, licences, and goodwill – in other words types of intangible assets. However, the Capital Account inflows are only about 1.3% of GDP and thus are relatively small, so it is prudent to focus on the larger components: the Current Account and the Financial Account.

The Current Account shows the flow of goods and services (i.e. imports and exports), as well as primary and secondary income. In the context of Namibia, the two biggest contributors to the Current Account are goods & services (i.e. the trade balance) and secondary income (mainly current transfers, such as SACU receipts).

Historically the goods and services account has usually been a drain on the overall Current Account as Namibia has rarely recorded a trade surplus. In other words, Namibia typically imports far more than she exports. These imports require foreign currency for payments. Moreover, since 2013, the country has experienced an average trade balance of -18.7% of total GDP. This deficit has narrowed in recent years, mostly due to lower import figures as household consumption has fallen.

The secondary income account typically improves the overall balance of the Current Account. This is where the SACU receipts are captured, which represent the single largest source of public revenue. Since 2009, this figure has propped up the current account with average inflows of 11.7%.

As a result of consistent trade deficits and less inflows from income (as the combination of primary and secondary income have averaged 10.5% of GDP since 2013), the country has run Current Account deficits averaging -8.2% of GDP since 2013. 

This alone would typically result in outflows from our foreign currency reserves, as the relatively small Capital Account cannot balance the Current Account deficit. Despite this, reserves have been rising since 2009 (as illustrated in the above chart). So, what is making up for the Current Account deficit and leading to rising reserves? To understand this one needs to view the reserve figure in the context of the Financial Account as well.

As illustrated above, over the past 7 years, Namibia has been a large recipient of financial flows into the country. For example, the country received significant financial inflows in Q4 2015, Q3 2016 and Q2 2017 which relate to Government issuing the second Eurobond, the GIPF swaps of local and foreign assets, and an African Development Bank loan, respectively. More recently, in Q2 2019, there was a large influx of portfolio flows due to a change in pension fund regulation.

These historical transitory flows, captured in the Financial Account, typically offset the drain on reserves from the Current Account deficit. The Financial Account captures flows such as the issuance of foreign debt or the flow of portfolio funds (such as pension fund assets), but also other flows like foreign direct investment. This highlights the importance of attracting foreign investment into our country, as this helps shore up our foreign reserves. Sufficient foreign reserves in turn help guarantee the 1:1 peg with the rand, providing some macroeconomic stability and providing for more stable, imported inflation.