Rising rates put pressure on Treasury
Bond yields have popped up again, with the long-dated R2044 (due in 21 years) at 11.99%. The yield of the R2044 is now about seven percentage points above the 5% that inflation has averaged over the past 10 years, and slightly higher than that relative to the SA Reserve Bank’s 4.5% inflation target.
In real terms, the SA government is paying more for long-term, fixed-rate borrowing, the most desirable form of debt for a cash manager, than it has since the early 2000s.
Inflation-linked bonds are also trading at exceptionally high levels. At 4.66% the I2046 (due in 23 years), is trading at levels comparable to those reached during the Covid-19 crisis in 2020. Before that, longdated inflation-linked bonds had only ever traded there in the mid-2000s.
At the short end of the rates curve, yields are also up. The R186 (due in three years), is trading at 8.85%, up from 8% in early February. This rate is still better than that at the long end of the yield curve but is more than a point above the prevailing repo rate of 7.75% and almost three points above the long-term inflation rate.
T-bill rates, the rates at which the state borrows for one year or less, are also up. This comes as no surprise as these rates rise with the repo rate. Yet, the repo rate has climbed in real terms. T-bill rates are thus at about 2% in real terms, on the high side compared with recent history. In offshore markets, 10year, dollar-denominated debt issued by SA is trading at 7.35%, or about four points above US treasury bonds. In early 2022, this bond was trading at yields below 6% and a spread of about three percentage points.
Some of the rise in rates here can be blamed on the rise in rates globally, but much of it is due to deterioration in SAspecific risks.
Looking at SA’s long-term borrowing rates over the past decade, there has been a step up in real borrowing costs from 2% to 4% in 2013/14 and to 6% in 2019/20.
This matches the deterioration in fiscal metrics linked to GDP underperformance, adverse policy choices and some bad luck over time.
SHOULD WORRY
The state’s gross borrowing requirement has risen from an average 5% of GDP in the decade to 2009 to about 10% in the decade to 2019 and a forecast 13% in the next three fiscal years.
The lift in the real rates of borrowing across multiple curves should worry the
Treasury. It makes managing expenditure far more difficult, as debt servicing costs eat into fiscal space and divert available resources from other state programmes.
The Treasury estimates it will cost a fifth of revenues to service debt in the next three years. For context, this ratio has doubled in the past 10 years. As more debt, issued at lower rates, is refinanced, the costs to service it will further escalate. Every cent used to service debt is foregone expenditure elsewhere.
Higher rates are also a material burden on the economy. Whatever rate the state borrows at is the benchmark for all other borrowers. Companies must pay rates that are in excess of what the state pays. If the state is paying 5% more in real terms for long-term funding than what it paid in 2011, all other borrowers are subject to the same cost of capital uplift. This has hurt investment and constrains the economy.
The daily debate in markets explains rate changes through the lens of current events. On these metrics, the fall in inflation should lead to lower funding costs as the year progresses. However, a longer-term view reveals that SA has been continuously squeezed by rising funding costs for a decade.
Without higher growth and real fiscal consolidation, expect this trend to continue.