Pension peril

Pension perilSavings targeted to fund deficit Analysts warn that the reliance on the domestic market to fund the budget deficit has eroded the stability of this savings pool as more and more of the assets in the pool are tied to government’s ability to repay its debts. This savings pool can only be relied upon for so long before it is compromised to a point where it will never recover. – IJG Securities Jo-Maré Duddy – To fund Namibia’s average annual deficit of N$14 billion over the next three fiscal years, government is likely to force asset managers to invest a much bigger chunk of pensions in its debt instruments, analysts agree.

Finance minister Iipumbu Shiimi’s new fiscal strategy shows that 52.5% of government’s total debt in 2021/22 will be from domestic sources.

The figure is set to increase to 57.8% in 2022/23 and to 60.3% in 2023/24. In 2019/20 it was a mere 35.6%.

In Namibian dollar terms, it means that domestic debt will nearly double from 2019/20 to 2023/24 – from about N$63.7 billion to an estimated N$124.2 billion.

“Simply put, this quantum of funding is not available in the country,” Cirrus Securities says. “Government will likely lean heavily on the pension savings of the Namibian people,” the analysts add.

IJG Securities also believes government will target Namibians’ retirement nest egg and warned: “This savings pool can only be relied upon for so long before it is compromised to a point where it will never recover … We are not at that point but moving towards it.”

DEFICIT

A drop of some N$3 billion in revenue from the Southern African Customs Union (Sacu) compared to 2020/21 left government with a budget deficit of nearly N$15.9 billion in 2021/22, which, according to Cirrus, remains “abnormally high”.

IJG says 2021/22 marks the eighth year in which the budget deficit will top N$8 billion, “necessitating the use of large amounts of debt to fund a very consumptive budget”.

The deficit is projected to remain the same in 2022/23 before falling to nearly N$11.4 billion in 2023/24. The 2020/21 deficit is estimated at nearly N$16.7 billion, “the largest in Namibian history by a large margin”, IJG points out.

Cirrus notes that Namibia also suffered a Sacu revenue shock in 2015/16, and that this was the main reason for the liquidity problems the country experienced in that fiscal year.

“While it seems that history is preparing to repeat itself, this time Namibia finds herself in a much weaker position after years of economic decline, erosion of reserves to withstand such a shock, and narrowing funding options,” the analysts say.

“Government is stuck between the proverbial rock and a hard place. Well-intended efforts to consolidate expenditure have resulted in a feedback loop of a shrinking economy resulting in faster revenue declines,” Cirrus say.

DEBT

Total debt stock is expected to grow 18.8% in the current financial year, from N$109.5 billion to N$130.0 billion, which includes the redemption of the first Eurobond and the GC21. The redemption of the Eurobond is likely to be underwritten by local institutional investors in exchange for bonds denominated in Namibian dollar.

Debt will continue to increase over the next two years to reach N$159 billion or 77.3% of gross domestic product (GDP) in 2023/24.

IJG has warned in various publications over the last five years that debt sustainability is likely to come into question in the future.

“With debt levels reaching 68.8% of GDP in 2020/21 we are rapidly seeing this scenario play out. Too little of this funding has found its way into increasing the productive capacity of the country, let alone improving education outcomes or healthcare standards,” IJG says.

The forecasts indicate that government will need to raise funding of N$26.8 billion in 2021/22, followed by N$21.2 billion in 2022/23 and N$15.4 billion in 2023/24. “This is N$63.4 billion in just three years,” Cirrus says.

According to the analysts: “With the increased funding requirement looming over the domestic market, the cost of funding is expected to rise for government, which will increase the interest expense cost, widening the overall deficit even further from current levels. As a result, the government frankly needs to get its house in order as Namibia’s hourglass is starting to run out.”

Cirrus continues: “Namibia is finding itself in a vicious cycle of increasing debt stock to finance its ever-growing deficits, without stimulating growth in the Namibian economy. This will prove very consequential to Namibia in the coming years.”

PENSION FUNDS

Namibia's government at present is not planning any net foreign debt issuance to fund its vast deficits and as a result, pension fund members’ assets are likely to be called upon, Cirrus believes.

“Without this, the Sacu shortfall could close to halve the country’s hard currency reserve levels in just two years, thereby raising concerns around the currency peg,” Cirrus says.

The analysts expect increases in local asset requirements for pension funds over the next three years, bringing more of the assets of these savers back into the country.

“This increases the concentration risk of these assets and exposes an ever-larger portion thereof to the local macroeconomic environment and the ever less creditworthy sovereign,” Cirrus says.

According to Cirrus, the borrowing requirement for the next three years constitutes close to 25% of the assets of the pension funds at present.

IJG points out that financial stability has always been high in Namibia with a very large regulated savings pool providing options that countries without such savings would not have.

“This asset has effectively enabled the ‘pro-growth fiscal consolidation’ stance taken by government over the last five years and the large deficits that have accompanied this balance between maintaining expenditure ceilings while revenues have stagnated. This asset has resulted in cheaper funding than would have been the case without it and enabled government to continue funding its operations without implementing structural reforms,” IJG says.

However, the analysts point out: “This process has eroded the stability of this savings pool as more and more of the assets in the pool are tied to government’s ability to repay its debts.”

Higher domestic asset requirements expected by IJG, as well as debt service costs which are approaching “debt trap levels” will further compromise this pool of assets as it increases exposure to a consumptive government on a potentially unsustainable debt trajectory, the analysts warn.

IJG says it should now be a national priority to implement structural reforms which would reduce the reliance on savers to fund inefficient government spending.

“There does not seem to be a recognition that this savings pool needs to be protected in order to contribute to future financial stability, not to mention serving the individuals who have diligently contributed to it to ensure a better tomorrow for themselves,” they say.

INTEREST

Interest payments for 2021/22 will account for 12.5% of total expenditure. Of these payments, N$6.1 billion is directed to domestic creditors and N$2.4 billion will be paid to foreign creditors. Interest payments will increase by 8.5% to N$9.2 billion in 2022/23 and will reach N$9.8 billion in 2023/24.

As a result, debt servicing costs are now expected to account for a total of 16.3% of total government revenue in 2021/22, increasing to 17.6% in 2022/23 and 17.1% in 2023/24.

“This is 6.3 percentage points higher than the self-imposed benchmark of 10%,” Cirrus says.

“Moreover, government debt servicing is expected to represent 4.6% of GDP, 0.2 percentage points higher than in 2020/21 and 1.6 percentage points higher than the self-imposed benchmark of 3%.”

Interest payments are now the third-largest expense accounted for in the budget and are expected to remain the third largest expense over the next two financial years, they note.

“In essence, government is increasingly borrowing to service debt, which is increasingly unsustainable,” Cirrus says.

IJG says interest cost as a proportion of revenue is “flirting with debt trap territory”.

According to the analysts: “Debt service costs are taking up more and more of government’s revenue, adding to the rigidity of the expenditure framework and effectively cannibalising the development budget along with other recurrent expenditures such as the wage bill.

“Thus precious little of the money raised in a given year is available to be allocated to expanding the productive capacity of the country which would aid in growing out of the current debt burden.”

REFORMS

IJG points out that most of the regulated institutional investors already comply with local asset requirements, except for the Government Institutions Pension Fund (GIPF).

“It remains to be seen whether this volume of debt can be raised without crowding out not only the rest of the domestic debt capital market, but also the equity market,” IJG says.

They continue: “In the absence of increases to domestic asset requirements it is highly likely that government raising this amount of debt will necessitate flows out of equities (dual-listed equities most likely) as well as crowding out banks and other corporates looking to raise debt capital. This would be detrimental to capital market development and could result in a rising cost of capital.”

According to IJG, structural reforms are necessary “for the simple reason that the expenditure framework is rigid and unable to cope with shocks to revenue”.

“Without structural reforms deficits remain large and debt costs become ever more unsustainable, eating into tax revenues that could be utilised in an effort to improve the lives of Namibians. The unseen cost of inefficient spending weighs heavily on the future productive capacity of individuals and infrastructure,” IJG says.

According to Cirrus, budget deficits have conventionally been funded with either net investment inflows, net foreign debt issuance, or pension fund inflows.

“An increasingly business-unfriendly environment in the country has caused net flows of investment capital to turn negative (outflows), which trend is expected to remain over the next three years, as the National Equitable Economic Empowerment Bill (NEEEB) and the Namibia Investment Promotion Act (Nipa) are enacted,” Cirrus says.