Grading is important
BONDS: FOREIGNERS OWN 37% OF SA BONDS
Reserve Bank estimates the post-downgrade bond selloff could be between R73 billion and R117 billion.
The total size of the SA government bond market is R2.12 trillion. Of that, according to the latest available statistics from National Treasury, foreigners own R781 billion, or 36.9%. This foreign ownership has fallen since the highs of late 2017 and early 2018. However, it remains higher than it has been for most of this decade.
The average percentage of foreign ownership of South African government bonds between 2011 and 2019 is 35.9%. It was lowest at the start of that period, and peaked at just under 43% in March 2018.
There has been a slight decline in the ratio of foreign holdings this year, but it is not substantial. In fact, up until the end of July, foreigners had been net buyers of local government bonds during 2019.
The Moody’s factor
The foreign ownership figure is significant because of the risk posed by a potential credit downgrade next year. Having cut the outlook on SA’s sovereign credit rating to negative, the most likely next step by Moody’s Investors Service is to lower the country’s rating to below investment grade.
Moody’s would be the last of the major rating agencies to do this, and the move would automatically trigger SA’s exclusion from the FTSE World Government Bond Index (WGBI). To be part of that index, a country’s domestic long-term bonds must be rated investment grade by either S&P or Moody’s.
SA has been part of the WGBI since 2012. What the impact of falling out of it would be remains highly uncertain.
Index tracking funds and those that are allowed to own bonds in the WGBI would be forced to sell their positions. However, estimates on how much money this represents vary substantially.
The South African Reserve Bank recently suggested that the selloff could be between $5 billion and $8 billion. That is between R73 billion and R117 billion.
Intellidex places the figure at this lower end of the range. It estimates that a downgrade could lead to $5 billion in outflows.
However, the Bank of New York Mellon has put the figure at between $8 billion and $12 billion. That could be as much as R176 billion. Other recent estimates have gone as high as $15 billion, or R220 billion.
The impact
This range is significant because R73 billion would be 3.5% of the total local bond market; R220 billion, on the other hand, is 10.4%. The former may not move the market that much, but if a 10th of SA’s government bonds were suddenly dumped, there would be a sharp reaction.
The greater risk is that the SA government is unable to sort out its finances.
As Jonathan Myerson, head of fixed income at Visio Capital, notes, the market is pricing in that fiscal consolidation will take place within five years.
“The question is becoming whether that consolidation is going to happen – and if it does not start in the 2020 budget, then the issues are much greater than a WGBI exclusion,” Myerson notes.
If the government does not rein in expenditure and halt its growing levels of debt, SA is facing multiple downgrades. And that will have much more meaningful implications for the market.