Mail & Guardian

SA rides emerging market wave

The pressure on Eskom bonds has eased and the rand has rallied but global events can reverse the gains

- Lynley Donnelly

With the country thrashing out a solution to its Eskom problems, foreign investors appear to have taken a renewed shine to South Africa, given the relatively improved performanc­e of government bonds and the rand in recent weeks.

But experts believe it has less to do with local efforts to allay investor unease or address concerns about the utility, deemed the biggest threat to the economy, and more to do with global events.

Despite the start of load-shedding late last year, indication­s of mounting Eskom losses and lacklustre economic data, government 10-year bond yields have steadily dropped from more than 9% in October to about 8.5% at the start of February.

Meanwhile, the currency was the best emerging market performer in January, gaining over 8% against the dollar, according to informatio­n from Stanlib.

There has been a sweeping change in sentiment towards emerging markets in the past few months, said Elena Ilkova, the fixed income and credit strategist of Rand Merchant Bank. “The more favourable emerging market growth outlook, combined with the change in the [United States] Federal Reserve’s hawkish stance, has seen most emerging markets benefit. South Africa’s sovereign bonds have reflected the changing sentiment.”

Last week the Fed left interest rates unchanged, saying it “will be patient” as it determines what future adjustment­s it will make, which has widely been read as confirmati­on of a softening on interest rate hikes.

This buoyancy in emerging market sentiment has coincided with a marked improvemen­t in credit spreads on Eskom bonds, particular­ly from the start of the year.

Credit spreads on Eskom’s foreigniss­ued bonds, particular­ly those not guaranteed by the government, have declined sharply in the past month — in the case of Eskom’s 10-year unguarante­ed bond as much as 170 basis points, according to data from Futuregrow­th Asset Management.

“There’s been a risk on environmen­t for emerging markets in the last three or so months, catalysed by the Federal Reserve adopting a more dovish monetary policy stance,” said Yunus January, interest rate market analyst at Futuregrow­th. He added that as a result there has been an increase of capital flows into emerging markets. Credit spreads on South Africa’s sovereign dollar denominate­d bonds have also been declining.

“But the compressio­n we are seeing in the Eskom dollar bonds has been significan­tly more,” said January. The shift is not explained by any material changes to Eskom’s fundamenta­ls, however, so there is clearly “something else at play”, he said.

The build-up to the State of the Nation address and expectatio­ns of an announceme­nt about resolving Eskom’s troubles may explain some of this.

But recent informatio­n coming out of Eskom has, if anything, been more alarming. At public hearings earlier in the week, it revealed it requires a 17% increase in tariffs in the first year of the upcoming three-year cycle instead of the 15% initially applied for. The hikes requested for the following two years were increased to 15.4% and 15.5%.

This came after the utility adjusted its applicatio­n to cater for newer data, including on its sales forecasts and its regulatory asset base, which inform how Eskom calculates its required revenue.

The utility’s chief financial officer, Calib Cassim, also told the hearings that the utility is expecting to make a net loss of R20-billion for the current financial year. This is well above the already dire forecast of losses of R15billion, which Eskom announced late last year. He added that these losses were expected to continue for the next few years, “even with the applied-for increases”.

But the positive sentiment towards emerging markets has, in South Africa’s case, coincided with significan­tly better messaging from the government on a plan to resolve Eskom’s difficulti­es, according to RMB’S Ilkova. Investors are finally beginning to believe in the government’s commitment to taking action to address Eskom’s structural issues, she said.

Eskom’s “significan­tly improved disclosure” about its problems — including neglected maintenanc­e at older coal stations, design and operationa­l defects at Kusile and Medupi and the need for emergency coal procuremen­t — helps in understand­ing the scope and size of the problem, Ilkova added.

The extent of the difficulti­es posed by Eskom notwithsta­nding, global factors very often have a much bigger effect on South African markets over time than domestic policy issues, said Kevin Lings, Stanlib’s chief economist.

The recent improvemen­t in the bond market and the strengthen­ing of the rand have been largely driven by foreign investor sentiment after the change in the signals from the Fed.

A significan­t amount of these capital flows are opportunis­tic and are aimed at taking advantage of the interest rate differenti­al between South Africa, whose rates are higher, and the US.

“A particular segment of the global investment community is opportunis­tic in nature and is not especially concerned by [locally driven] events,” Lings said.

But South Africa relies heavily on these portfolio flows and is particular­ly vulnerable to their reversal, he said.

The way to balance this is to attract long-term foreign direct investment and this is where conundrums such as Eskom and other domestic policy problems do affect the economy’s ability to attract the more stable kind of investment that establishe­s businesses, creates jobs and boosts infrastruc­ture developmen­t, Lings said.

It is very possible that, if global trade tensions ease, concerns about China’s growth dissipate and growth in the US economy picks up — all factors influencin­g the US central bank’s position on rates — the Fed may begin hiking rates again.

If this happens, sentiment is again likely to turn against emerging markets and foreign flows may reverse, even if it coincides with South Africa making material headway in addressing Eskom’s problems, Lings said.

 ??  ??

Newspapers in English

Newspapers from South Africa