Jury out on result of eager bond uptake
International investors seem as greedy as before to buy SA’s bonds, despite it all. That’s just as well given that the government is being forced to borrow much more than it had planned. But the more it buys, the more vulnerable SA becomes.
The latest bond market success was on September 20, when the government successfully placed $2.5bn in dollar bonds on the international market.
The budget had envisaged $2bn in foreign bond issuance. But the Treasury evidently took advantage of favourable conditions to issue more, just as it did in 2016, when it went to international capital markets twice to raise a record total of $4.25bn.
Then, Pravin Gordhan was finance minister. Now, it is Malusi Gigaba, with all that has happened to savage confidence in SA’s economy and institutions over the past year. That made it even more remarkable that SA could go to the market and issue dollar bonds at pricing that was even more attractive than a year ago.
The yield on a bond is the inverse of its price, so the lower the yield the issuer has to pay to get the investor to buy the bond, the better the pricing. Markets look at the spread or gap between the yield and equivalent US treasury bonds. In SA’s case, the 30-year dollar bond was priced at a spread of 283.7 basis points above 30-year US treasuries, which was better than the 271.9 basis point spread in September 2016.
The finance ministry hailed this as a vote of confidence in SA’s sound policies, but the success was more about the global search for yield than it was about SA’s own merits.
How long the yield mania will last is a question, and the risk is that the rand crashes, with other emerging market currencies, and meeting the interest payments on money that seemed cheap becomes much more expensive.
SA has until now kept that risk quite modest: foreign debt is still only about 10% of all government debt. The real risk is in the domestic debt — government bonds that are issued in rand on the home market, not in dollars or euros in foreign markets. The latest figures show SA is the most vulnerable yet to a sudden loss of international appetite for its bonds, and of those of emerging markets generally.
Treasury figures show foreign ownership of domestic rand bonds hit a record high of 40.5% in June, up from 36% in January and almost double the 21% in 2010.
Foreigners are even more dominant, if the government’s inflation-linked bonds, which are owned mainly by domestic investors, are excluded and just fixed-rate bonds are considered, such as the benchmark R186, where the foreign share is well more than 50%.
As global funds have been taking up a much higher share of each domestic bond issue than local fund managers, their share has risen. The government has been issuing more debt on the market than it had planned because revenues have been falling short and the deficit is expected to be higher. That would normally mean yields would rise, making it more expensive to borrow. But they haven’t, partly because Eskom hasn’t been going to the bond market as it normally does, so the demand has gone into government bonds instead — as has the strong demand from foreign investors in search of yields that are better than they can get at home.
Year to date, about R63bn in foreign capital has flowed into SA’s bond markets. Foreign bond market investors are essentially providing much of the financing for SA’s growing budget deficits, and so helping fund the balance of payments deficit.
In recent months, those flows have done nothing for the rand, which has been edging downwards. A likely explanation is that those foreign investors are buying the bonds but selling rand, hedging out their currency exposure so they don’t have to worry about a rand crash if SA gets itself into even more trouble — they like the yield but that doesn’t mean they have confidence in SA. Those twin deficits and the dependence on foreign “hot money” flows make SA extremely vulnerable to a “sudden stop”, or even a reversal of capital flows, especially if the rating on SA’s local currency, rand bonds is junked and the tracker funds invested in global local currency bond indices are forced to sell. Citi has estimated outflows of R80bn to R120bn.
The big question is how much of that wash of inflows in recent years has been from index tracker funds who would sell if SA were downgraded — and how much is from “real money” investors. The real-money folk might be longer-term investors, but they could also be speculators chasing yield. Puzzling out how much of it is hot money, and how hot the hot money is, is key to exactly how vulnerable SA is. There’s little question that the more SA has to borrow, the more vulnerable it will become.
THOSE TWIN DEFICITS AND THE DEPENDENCE ON FOREIGN ‘HOT MONEY’ FLOWS MAKE SA EXTREMELY VULNERABLE TO A ‘SUDDEN STOP’