• Over the past three weeks, foreigners have piled into South African bonds as they search for higher yields.
  • The demand for SA bonds should make it cheaper for government to borrow money - easing the load on taxpayers.
  • But the foreign buying may not be sustainable.
  • For more articles, go to www.BusinessInsider.co.za.

Last week, foreign investors were net buyers of R4 billion in South African bonds, the latest JSE data shows. That followed two previous weeks of solid buying, with foreigners also net buyers of billions in local bonds during that time.

So far this year, foreigners sold R63 billion in SA bonds – but this is much less than the large outflow, of between R110 billion and R250 billion, that analysts expected following SA’s sovereign credit rating downgrade to junk by Moody’s in March.

It was feared that Moody’s downgrade would trigger a destructive sell-off as foreign funds which can only invest in investment-grade bonds had to dump local bonds. In truth, the selling was much tamer than expected.

Still, foreign investors now hold less than 32% of the issued SA bonds - from 42% years ago.

Now some of the world’s biggest investment banks, including Goldman Sachs, Deutsche Bank, and Bank of America are recommending that their clients buy South African government bonds.

Last week, at Treasury’s bond auction, demand for SA bonds outstripped supply by almost three times: government auctioned off R2.1 billion in R186 bonds, while bids of R5.97 billion were received. Investors received a yield of around 7.5%.

South Africa yields are standing out, says Wikus Furstenberg, portfolio manager and head of interest rate process at Futuregrowth Asset Management.

Many government bonds – including the US and most of the rich European countries – now offer negative yields. This means that investors are paying these countries for the privilege of lending them money. In comparison, South African bonds, are still offering an attractive, positive rate.

After climbing to almost 11.5% in March, key government bond yields dipped to around 7.5% last week. This means government can offer much lower rates of interest when it issues new bonds – which should ease the load on taxpayers.

Local bonds have also received a boost from the Reserve Bank, which has (basically) been creating money out of thin air to buy government bonds. 

This was in response to a significant drop in market liquidity at the start of the coronavirus crisis. The Reserve Bank bought just more than R30 billion in bonds in April and May. The buying of government bonds in the secondary market intended to prevent the local bond market from freezing up, Furstenberg says.

But he cautions that it would be undesirable for the bank to continue doing this. "It most certainly is not ideal for market prices to be influenced by central bank intervention. Although the Bank categorically stated that the reason for the jump in the SA government securities holding on its balance sheet is not to fund the budget deficit, it would become harder to convince the market otherwise if this continues unabated, even though its buying is limited to secondary market activity."

The current foreign interest in South African bonds may also not be sustainable, as the country's fiscal outlook is increasingly shaky.

South Africa’s GDP to debt ratio is currently around 66%, but on track to blow out to 90% in the next two years in light of the downward pressure on economic growth, pressure on tax revenue collection and the inability of the state to cut current expenditure to offset this.

While there may be a new normal in indebtedness following the coronavirus crisis – most other countries have also pumped billions into their economies – there is concern about how the already-spluttering South African economy will bounce back, as well as how longstanding structural issues will be resolved.

Chiefly among them is the shrinking tax base, Furstenberg says. Even before the coronavirus crisis, tax revenue was under pressure - and government’s decision to forego tax income from cigarettes and alcohol sales during the first phases of lockdown will not help.

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