South African government bonds offer refuge to investors in search of income

By David Whitehouse

South Africa's President Cyril Ramaphosa and finance minister Tito Mboweni (AP)

The latest article in our series on income investing in Africa considers the case for South African government bonds.

Previously we have considered Grit Real Estate, Anglo American, Mondi and Aspen. The articles are not presented as investment advice and readers should take professional advice and/or do their own research.

What will it take to end South Africa’s love affair with equities?

At over 200%, the ratio of the Johannesburg stock market’s capitalisation to the country’s GDP is higher than anywhere else in the world.

Meanwhile, the yield on 2-year South African government bonds currently stand at 6.7%, with 8.2% available on 10-year paper.

A switch by South African institutions into bonds would provide support for international investors who face negative bond yields in their domestic markets and who need to find new homes for their money.

Current yields indicate that the market is already pricing South Africa as sub-investment grade, argues Grace Debeila, co-portfolio manager at Mergence Investment Managers in Cape Town. That suggests that the loss of the last remaining investment-grade rating with Moody’s would “confirm their perception rather than change their outlook of sovereign risk in a meaningful way,” she says.

The importance of a downgrade would lie in the exclusion of South Africa’s debt from global indices that track investment grade securities. This could briefly cause a spike upward in yields, but it would also attract buyers of sub-investment grade debt, Debeila says.

Many foreign investors have already bailed out: overseas ownership of South African government debt slumped to 37% at the end of August.

Bottom of Form

Yet as dire as South Africa’s financial situation is, the country is not yet at the point where an IMF bailout is required, Debeila argues.

The risks of a bailout being needed would increase if there were multiple sovereign downgrades deeper into sub-investment grade territory, acceleration of flight of and an inability to borrow at reasonable rates. “For now, these risks remain muted,” she argues.

The country’s central bank has kept its credibility, while the floating exchange rate regime and healthy level of foreign currency reserves help in managing the balance of payments, she says.

Hard currency debt

Crucially, Debeila says, South Africa’s issuance of hard currency debt is a relatively small proportion of overall debt – 10% at the last budget presentation in February. Keeping it low will help to avoid the need for a bailout, she says.

A higher proportion of hard currency debt is initially positive for the central bank’s foreign reserve balance. But in the long run it increases the risk of being unable to manage the country’s balance of payments in a distress scenario.

Updated figures will become clear at the treasury’s medium-term budget policy presentation on October 30. Moody’s is due to give a rating review on South Africa by November 1.

The country also has the advantage of time.

Much of its borrowing has been in the form of long-dated bonds, so there is still scope for gradual management of economic reforms and public finances.

That window won’t last forever: Debeila sees little room left to increase taxes, so it is the expenditure side of the budget that will have to take the strain.

So far, political pressures have prevented these measures being taken, Debeila says.

Debeila also sees a potential red flag is the treasury’s suggestion of increased issuance of shorter-term T-bills rather than long-dated debt.

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