(Bloomberg) -- With South Africa running out of options to fund a widening budget deficit and contain runaway debt, the government has decided for the first time to tap billions of dollars of paper profits earned on its foreign reserves. The rand jumped on the announcement of the drawdown from the socalled contingency account, suggesting that investors see the plan as a viable way to bring state liabilities down to a more manageable level. 

1. How does the contingency reserve account work?

The Gold & Foreign Exchange Contingency Reserve Account reflects movements in the value of the central bank’s stock of gold, foreign exchange, and forwards or swaps agreements. By way of example, if the government bought $1 billion of gold and the value moved up to $1.5 billion, the $500 million gain would be reflected in the contingency account. The fund balance can fluctuate widely, depending on how the assets perform.

2. How much money does the South African government want to access?

The account reflected a positive balance of 507.3 billion rand ($26.9 billion) in January 2024, up from just 1.8 billion rand in 2006. In his February budget speech, Finance Minister Enoch Godongwana announced that the National Treasury would utilize 150 billion rand over three years to help finance its borrowing requirement. The Treasury will drawn down 100 billion rand in the year through March 2025 and a further 25 billion rand in each of the following two fiscal years. An additional 100 billion rand will initially be allocated to the central bank to protect its balance sheet and fund the cost of this restructuring. Over time that money will also be transferred to the government as the bank generates its own contingency buffer. The remaining 250 billion rand stays in GFECRA to shield the country’s reserves from currency losses.

3. How will the process work?

The Treasury says it will agree a new framework with the South African Reserve Bank that will ensure the funds are used to curb government borrowing and strengthen the central bank’s equity position. The assets in GFECRA won’t be sold. Instead, the central bank will create a liability — something that its Governor Lesetja Kganyago described as similar to “printing money” — which it will hand to the Treasury and finance at its benchmark policy rate of 8.25%. The arrangement will save the Treasury 30 billion rand over the next three fiscal years. The money that stays with the central bank will be placed in a contingency fund and used to pay so-called sterilization costs incurred as it mops up excess liquidity. 

4. Would that be a good idea?

The GFECRA, in conjunction with the country’s foreign reserves, can be utilized to maintain liquidity in an economic crisis and meet the country’s international financial obligations such as settling debt denominated in foreign currency, paying for imports and absorbing sudden capital movements. If the Treasury sticks to its commitment to put the money to good use, it will relieve pressure on state finances and the bond markets, and be viewed positively. Kganyago had previously warned that investors may be sent “running for the hills” if they doubt the country is able to meet its obligations. There would also be a risk of a run on the rand. The Treasury insists that the balance in the account is now larger than any plausible losses on the reserves that arise due to rand appreciation. 

5. What happens in other countries?

A number of nations’ central banks that hold mostly foreign-exchange assets on their balance sheets, including those in Switzerland, Chile and Poland, periodically transfer some or all of the gains made from valuation adjustments to the government, according to a draft research paper by Amia Capital LLP economists Pedro Maia and Annik Ketterle, and Guido Maia, a London School of Economics PhD candidate. The frequency and mechanism through which transfers take place differ depending on national legislation, they said. The changes will bring South Africa in line with its peers, according to the Treasury.

--With assistance from Monique Vanek and Ntando Thukwana.

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