SUNDAY TIMES - Search for yield props up bond market
Sunday Times Business By PERICLES ANETOS and ASHA SPECKMAN, 2017-04-16 00:00:00.0

Search for yield props up bond market

CAN HE WALK THE TALK? Finance Minister Malusi Gigaba is ’saying all the right things, but doesn’t have a proven track record’.

The effects of political tension - the catalyst for South Africa's credit-ratings downgrades a week ago - propped up the country's bond market as investors piled into government debt this week.

The downgrade to junk status increased the yield on South Africa's debt raising the government's borrowing costs.

The rand traded firmer this week - a direct result of foreign investors buying into the currency via bonds.

The yield on the R186 benchmark 10-year government bond firmed to below 9% after the sell-off that began on March 27, the Monday after former finance minister Pravin Gordhan was fired.   

Experts believe the turmoil in other emerging markets and waning expectations for growth-inducing policies from US President Donald Trump have supported continued interest in local assets.

Jack Deino, head of emerging markets: corporate debt investments at BlackRock, said on Tuesday that South Africa experienced a level of fiscal deterioration similar to that of Brazil, which slid fully into junk status last year.

The countries trade on a similar valuation but South Africa was slightly worse off where it concerned improvements in the fiscus.

Deino said that the downgrades South Africa had experienced had turned investors away but at the same time investors were limited in their choices as to where to invest.

US-based BlackRock is one of the world's biggest bond investors.

South Africa's corporate debt, either state-owned or publicly traded, was attractive to investors, he said.

Investor appetite for South African assets helped steady the rand this week, with the currency strengthening over the week, gaining 3.91% to R13.40 to the dollar late on Thursday.

South African markets were closed on Friday and will also be closed tomorrow for the Easter long weekend.

The rand traded at R12.31 to the dollar just before the news broke that Pravin Gordhan was recalled from his international roadshow at the tail-end of March.

George Glynos, MD at ETM Analytics, said: "We're not in a full-blown crisis, but if we carry on down this path we can easily get there."

Michelle Wohlberg, a bond analyst at Rand Merchant Bank Global Market Research, said opportunities for higher returns elsewhere in the world were limited.

South Africa's yield curve was more attractive to investors compared to Russia or Turkey, she said. But this would be shattered if the local currency rating was downgraded to junk by Moody's or S&P.

Fitch has already downgraded South Africa's local currency rating to junk.

Wohlberg said a ratings downgrade to junk by Moody's, which currently rates the country two notches above investment grade, would be a shock that was not already priced into the currency and bond markets.

"I think the reason that emerging markets and the South African market are doing so well is because there are favourable emerging-market factors at the moment," she said.

This included to some extent that the optimism in the market from Trump's presidency had fizzled out and was benefiting emerging markets.

Shalin Bhagwan, head of fixed income at Ashburton Investments, said the downgrade took place in an environment that favoured emerging-market economies.

"We've been lifted along in that rising tide. However, when the tide goes out we get to see who was wearing a bathing suit or not."

Bhagwan said South Africa's bond markets would see a significant sell-off "if the current trajectory continues. We have not yet seen the worst of the downgrades."

"Whilst the new finance minister is saying all the right things, the new minister of finance does not come with a proven track record."

Bond flows are spurred by the premium that investors obtain from extending credit to countries rated sub-investment grade as these investments are deemed to be riskier.

South Africa is likely to be downgraded in the coming weeks by Moody's and it may still attract a further downgrade by S&P Global Ratings on its local currency rating.

S&P was the first agency to tip the country into junk status last week.

The downgrades come at a time when the country is battling to resuscitate economic growth, create jobs and lift private fixed capital investment.

Last week Fitch cut South Africa's foreign currency debt rating and local currency debt rating to junk while S&P only reduced the foreign currency rating.

Both credit ratings agencies cited political tension and the impact it could have on fiscal policy, which would ultimately impact the country's ability to repay its debt.

While international investors find South Africa's yields attractive, the higher borrowing costs the government faces will prove debilitating.

Based on the benchmark R186 government bond, South Africa's debt costs had increased from less than 8.5% before Gordhan was recalled from London to 8.84% in late Thursday in trade.

"Small change it is not," says political analyst JP Landman.

"On a full year's borrowings by government it amounts to about R2.6-million per day ... for 365 days. That is about 8000 RDP houses [21 houses per day] or support for about 24000 students from the 'missing middle' to go to university."

Last year the rand firmed 11% against the dollar, and despite the polarising politics of recent weeks, the currency is still 1.29% stronger against the US dollar since January.

Up until President Jacob Zuma's cabinet reshuffle, the rand's strength had contributed to a benign inflation outlook and had some economists pencilling in a possible interest rate cut - the first in five years.

In an interview on the sidelines of a monetary policy forum event in Soweto on Tuesday, Reserve Bank governor Lesetja Kganyago affirmed the central bank's view that inflation would return to its 3% to 6% target band during the second quarter of this year, but rand concerns had heightened because of the downgrades.

"It means we are going to have to be cognisant of the fact that in this instance the exchange rate would be putting an upward pressure on the inflation outlook," he said.