Journal Issue

Chapter I: Introduction

Olivier Basdevant, and Borislava Mircheva
Published Date:
February 2013
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The Kingdom of Swaziland (hereinafter “Swaziland”) is a small, open economy bordering Mozambique and South Africa with a population of 1.1 million people. It is a landlocked country with an economy heavily dependent on concentrates, sugar exports, and tourism, and with more than 80 percent of its imports originating from South Africa. Swaziland is a member of the Southern African Customs Union (SACU) and has increasingly relied on SACU transfers in the last few years as a source of fiscal revenue and foreign exchange receipts. Its currency, the lilangeni, is pegged at parity with the South African rand under the Common Monetary Area (Box 1). The rand is also legal tender in Swaziland.

After two difficult fiscal years,1 Swaziland has regained fiscal space with a sharp increase in transfers from the Southern African Customs Union. The deficits accumulated during these two fiscal years (13.4 and 6.0 percent of GDP in 2011/12 and 2012/13, respectively) led to: (i) a significant drawdown of gross official reserves at the central bank, (ii) significant domestic borrowing, and (iii) an accumulation of domestic payment arrears, estimated at E 1.6 billion (5.4 percent of GDP) at end-March 2012. Arrears largely affected pension funds and government suppliers (each account for about 40 percent of the total stock of arrears). As a result, real GDP growth is projected to contract by 1.5 percent in 2012, mostly because of the accumulated arrears, a stagnant credit to the private sector, and weak confidence in Swaziland fiscal and external sustainability. With SACU transfers increasing from about 10 percent of GDP in 2011/12 to 22.5 percent in 2012/13, some fiscal space was regained. The windfall revenue has been used to repay an advance taken by the central bank and to reduce arrears by E 250 million as of end-September 2012. An additional E 720 million in arrears to the public pension fund have been restructured into a three-year loan. Higher SACU transfers have also improved external balances by reducing the current account deficit and increasing central bank reserves. Reserves are broadly adequate at E 6.0 billion (3.1 months of imports) at end-November 2012, a significant improvement from the E 3.7 billion recorded at end-March 2012.

Measures have been taken by the authorities to reduce Swaziland’s vulnerabilities. Revenue collection was improved with the successful introduction of a value-added tax (VAT) in April 2012, complemented with continued improvements in revenue administration. Moreover, a new PFM bill has been drafted, with technical assistance from the IMF, which is expected to be presented to parliament in early 2013. Furthermore, a new supervisory agency, the Financial Services Regulatory Authority (FSRA), became operational in late 2012. The FSRA is taking upon the supervision of non-bank financial institutions and working towards the creating and implementation of a regulatory framework.

While these implemented measures are a positive step, Swaziland’s external position is still unsustainable partly because of the additional need for fiscal adjustment (Table 1), and partly because of potential spillovers of adverse shocks in the global economy (Chapter II). The large fiscal imbalances in the last two years have had a negative impact on the external current account balance and the gross official reserve position of the central bank (Chapter III). This weakening of the fiscal and external positions has in turn had a negative impact on the private and financial sectors (Chapter IV), thus creating additional external vulnerabilities. Restoring confidence in the Swaziland economy would require implementing an adequate fiscal adjustment and promoting private-sector-led growth (Chapter V).

Table 1.External Sector Vulnerabilities
Overall assessment: an unsustainable external position under current policiesBackground. The lack of fiscal adjustment has led to a series of external vulnerabilities: a large current account deficit, portfolio outflows, and a weakening reserve position.

Potential policy responses. The parity with the South African rand should remain the anchor of macroeconomic stability. Restoring external sustainability would primarily be achieved with fiscal adjustment coupled with structural improvements in external competitiveness. The latter would be achieved with continued progress on creating a favorable environment for higher private sector-led growth.
Current account: vulnerabilities stemming from fiscal imbalancesBackground. After a temporary rebound in 2012 and 2013 owing to windfall SACU transfers, the current account deficit is projected to remain unsustainably high at about 7 percent of GDP over the medium term, absent fiscal adjustment.

Assessment. Current account developments are largely dominated by the fiscal sector. Priority could be given to reducing the current account deficit by combining a fiscal adjustment and measures to strengthen export-led growth.
Real exchange rate: a strong overvaluationBackground. According to all methods used, the exchange rate remains overvalued in the range of 28–38 percent. The overvaluation largely is a result of fiscal imbalances.

Assessment. An adjustment in the parity would not be desirable because Swaziland benefits significantly from having its currency pegged at parity with the South African rand, which is also legal tender. Policy options to reduce the overvaluation should be based on an overall fiscal adjustment of about 6 percent of GDP over the medium term and measures to increase export-led growth.
Capital and financial account: vulnerabilities to portfolio outflowsBackground. Swaziland’s financial account is vulnerable to portfolio outflows, while the government has not yet secured external budget support.

Assessment. Portfolio outflows raise concerns about financial sector stability. Immediate actions are needed to restore confidence while implementing a strategy to secure external inflows (private investment and external budget support).
FX reserves: A current level broadly adequate, but risks remainBackground. At present, the level of reserves is broadly adequate to cover the potential external vulnerabilities mentioned above.

Assessment. A fiscal adjustment strategy would need to be coupled with a strategy to maintain the level of reserves at an adequate level throughout the medium term.
Foreign assets and liabilities position: public debt is unsustainable and would result in reserves depletionBackground. Swaziland’s foreign assets and liabilities are dominated by a projected weakening of the reserve position, and public debt dynamics that would weigh more on reserves than external debt, owing to the lack of access to external financing.

Assessment. While the net International Investment Position does not pose an immediate risk, it reinforces the need for buttressing reserves through a growth-enhancing fiscal adjustment.

Box 1.The Common Monetary Area (CMA)1

The Common Monetary Area (CMA) is a monetary union in which Lesotho, Namibia, and Swaziland have linked their domestic currencies to the South African rand. Within the CMA, each country issues its own currency, and bilateral agreements define where these currencies are legal tender. The smaller countries (Lesotho, Namibia, Swaziland—LNS) have pegged their currency 1-to-1 to the South African rand. The South African Reserve Bank (SARB) has adopted an inflation targeting system and lets the rand float freely against other major currencies. The South African rand is also legal tender in all member countries of the CMA, while the LNS currencies are only legal tender in their own country.

The CMA is not a full currency union. There is no common central bank, no common pool of reserves, and no regional surveillance of domestic policies. The exchange rate arrangements of the smaller countries under the CMA share certain characteristics of a currency board—domestic currency issues are required to be fully backed by foreign reserves (except for Swaziland, where it is not a requirement). Unlike a typical currency board, there is no legal restriction prohibiting the central bank of a small member country from acquiring domestic assets. The small member countries have not made an irrevocable commitment to keep a given exchange rate level against the South African rand. Member countries are not required to provide mutual support if the exchange rate peg comes under pressure. There is no formal mechanism for fiscal transfers to cushion the impact of asymmetric shocks. However, the SARB will, on request, make the required foreign exchange available to other members of the CMA.

For LNS, the local currency and the rand are perfect substitutes, with no rand-conversion cost and no restrictions on transfers of funds, whether for current or capital transactions. All four members of the CMA also belong to the Southern African Customs Union (SACU).2 As a consequence, capital and goods are highly mobile across the CMA region.3 The close regional integration brings large benefits in normal times to LNS, because they benefit from South African investments and access to the South African market. However, this advantage can reverse itself in the event of a crisis, facilitating capital outflows, notably to South Africa. This is exacerbated even further by the absence of conversion costs between the local currency and the rand.

Contrary to other CMA members, Swaziland has the option to adjust its exchange rate unilaterally under the bilateral agreement of 1992. Unlike the agreements with Lesotho and Namibia, the Swaziland agreement does not require Swaziland to cover its currency in circulation 1-to-1 with the equivalent amount of gross official reserves of the Central Bank of Swaziland (CBS). Swaziland reintroduced the rand as legal tender in 2003.

1 See Wang and others (2007) for further discussion on the CMA.2 Botswana is also a member of SACU but is not a member of the CMA.3 The only exceptions result from the member countries’ investment or prudential liquidity requirements prescribed for financial institutions.

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