News analysis

Finance minister Tito Mboweni at the press confere
Finance minister Tito Mboweni will table an emergency budget in June, to accommodate Covid-19 related expenses. (Gallo Images, Brenton Geach)
  • South African government bond yields have staged a strong recovery after a coronavirus-related blow-out in March.
  • It is now clear that the expectations of a large outflow, of between R110 billion and R250 billion due to SA's junk rating, were overestimated. 
  • But SA could still face a financing squeeze as its debt piles higher.
  • For more articles, go to www.BusinessInsider.co.za.

South African government bond yields have recovered after an almighty coronavirus-related blow-out - as it becomes increasingly clear that much of the expected massive outflows due to the junk downgrade failed to materialise.

But the country is not out of the woods yet.

At the end of March, ratings agency Moody’s stripped South Africa of its investment grade rating, downgrading government bonds to “junk”. A “junk” rating means there's a bigger chance that the government won’t be able to pay back its debts.

Previously, because SA government bonds were rated investment grade, they were included in the most important group of government bonds, the FTSE World Government Bond Index (WGBI).   

The index doesn’t allow junk bonds, so SA bonds were kicked out. All the many overseas investment funds that track that index – and those funds that are only allowed to invest in investment-grade bonds – had to sell their South African government bonds.

This was supposed to trigger massive outflows, which Bank of America previously estimated could reach $14 billion (R257 billion, at the current exchange rate). The French bank Credit Agricole expected outflows of between $9 billion and $13.5 billion (R250 billion), while the Bank of New York Mellon's forecast was between $8 billion and $12 billion (R220 billion), according to a Bloomberg report.

The likes of Barclays ($6 billion) and Citigroup ($6.6 billion) were more optimistic.

In the end, the outflows were wildly overestimated, says Nishan Maharaj, head of fixed interest investment at Coronation Fund Managers. Most of the outflows came through in March (R60 billion), with only R15 billion in April, he says. The total outflows came to R75 billion – around $4 billion – since the downgrade. (In total, foreigners have been net sellers of R71 billion in South African bonds in the year so far. In the same period last year, they were net buyers of R16 billion.)

Meanwhile, after a massive spike in government bond yields – the yield on the 10-year South African bond climbed to almost 12.5% in March - yields have returned to more comfortable levels, of around 9%.

Bond yields are important because they guide the interest rates the government ends up paying to borrow money. If bonds yields are high, government will have to borrow money at higher interest rates. The state will have to pay billions more in interest to fund local roads, hospitals, and services. (If government had to issue new bonds at 12.5%, its interest bill would be around 35% more expensive that at current rates.)

Maharaj says local government bonds were supported by the recent actions of the South African Reserve Bank, including its decision to buy government bonds, and to offer so-called “term repos”, whereby the central bank lends longer-term money to the banks against government bonds.

In addition, the recent sharp cuts in the repo rate to 4.25% also provided a strong anchor for government bond yields, he says. 

“The combination of these actions helped ease pressure in the bond market and, as risk appetite returned globally, demand for South African government bonds (which are also quite cheap relative to their emerging market peer group) returned, which helped compress yields."

Many government bonds – including the US – 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.

For now, demand remains strong for local bonds: at a Treasury auction this week for R2.1 billion in bonds, government received bids of more than R4.1 billion.

But Maharaj warns that while bonds have staged a recovery, which should bring the cost of government financing down, these levels would need to be maintained on a more sustained basis. 

“This will depend to a large extent on the adjustment budget that finance minister Tito Mboweni will present in June, and by how much the public sector borrowing requirement will increase."

Standard & Poor’s expects that government debt could hit 75% of GDP by the end of the year, and reach 84.7% by 2023. A decade ago, South Africa’s debt was at 33% of GDP.

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