The private sector could pull the plug on government bonds if it really wanted to
Business is losing its patience. An advertisement in Sunday’s main papers by Business Leadership SA was unrestrained in criticising President Jacob Zuma’s firing of finance minister Pravin Gordhan, ignorance of the economic effects of junk status, and the propaganda campaign being waged against those who criticise him and the Gupta family.
It is unprecedented for business to take such an aggressive stance. The ad decried the poor management of state institutions and enterprises and demanded a return to independent institutions, an effective state and respect for the Constitution.
But if the private sector is so concerned about the direction of government under Zuma, it has a powerful tool it can use: its funding of the state. I’m not talking about taxes – those are a legal requirement. But every week, the private sector invests billions of rands in government bonds to fund the budget deficit. It could stop doing it both as an act of protest and because it has a fiduciary responsibility to investors not to expose them to undue risk.
The government is highly dependent on private investors to finance it. It has budgeted to raise R242bn in the bond market this year. That works out to around R4.7bn a week in new bonds. The loss of investment grade from some ratings agencies has dramatically increased the yield on bonds already in the market. But what really matters is the yield that government has to pay for new bonds it issues. The market yield increase is a hit to the current owners of those bonds, but makes no difference to the cash flows of the government. That money is already in the bank and the coupon payments the government makes won’t change. It is the money that the government has to raise in the future that is important.
The market yield increase provides an indication of how much more it is going to cost the government, and ultimately taxpayers, to raise the R242bn this year. The Treasury can box clever – the market yields have increased for bonds of all maturities, but particularly in the short and long term.
The government can shift its issuance programme to favour bonds that have maturities of two to 10 years, slowing issuance of short-term treasuries and bonds with maturities more than 10 years. It can also shift more into inflationlinked bonds, which will see more demand as investors try to protect themselves against higher expected inflation.
So the actual cost effect on the government can be managed down in this way, to probably less than a percentage point in extra yield on the R242bn of issuance to be done. That’s still billions a year of extra cost, compounding each year in the future, but not as high as some figures that have been quoted.
That would be dramatically different if the private sector did not support government issuance until institutional integrity was restored to the Treasury and the state-owned enterprises that issue bonds. As far as we know, Gordhan and his deputy Mcebisi Jonas were fired simply because they were opposed to the nuclear deal without a proven financial case, were investigating tenders done by state-owned enterprises, were supporting the banks in their refusal to do business with the Guptas, and were generally insisting on rigorous financial management of the state.
The reasons Zuma has given for his dismissal – first a laughably poor “intelligence” report suggesting Gordhan was trying to overthrow the state, and then the claim that their relationship had broken down without any evidence of Gordhan and Jonas being anything but polite to the president – are simply not credible. So we have little choice but to conclude that Zuma’s move is intended to damage the good financial management of the state. Fund managers have a fiduciary responsibility to ensure their investors’ money is going to be well managed, and right now they cannot think that of the state.
Of course, some investors need to invest in bonds. The return profile of government bonds are critical to certain types of investment objectives, particularly those who need lower-risk portfolios and protection against inflation. Professional investors will have different levels of flexibility, depending on their mandates. Some can move their investments into commercial paper issued by the banks and similar lenders, rather than the state. Others can refuse to take part in new bond auctions, but instead buy the bonds already available.
Of course, these are hard technically to achieve because the auctions and secondary market can be arbitraged against each other, but by withdrawing demand from auctions, a clear signal will be sent.
Business is now talking tough, but it could also act tough. There is precedent: Old Mutual subsidiary Futuregrowth, one of the largest bond fund managers in the country, last year shocked the market by announcing it was boycotting the bonds of several state enterprises. It said at the time it had noted reports which “strongly hint of conflict between branches of SA’s government and “the possible machinations of patronage networks”.
Well, that is surely much more the case now. Bond investors should take action through an investment strike.