The total size of the South African 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%.
As the table below shows, 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.
|Foreign ownership of SA government bonds|
Source: National Treasury
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 South Africa’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 South Africa’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.
South Africa 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 also 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.
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 South Africa’s government bonds were suddenly dumped, there would be a sharp reaction.
Most analysts seem to think that the higher end of the range is unlikely. That is because a downgrade has been anticipated for so long that it is reasonable to expect that many funds have pre-sold South African bonds where this has been possible.
If that is the case, then the downgrade is already largely ‘priced in’.
However, one cannot ignore that local bonds offer easily the highest yields of any of those in the WGBI, as the Bloomberg chart below indicates. This means it is very difficult for fund managers to be too heavily underweight without risking underperformance at the same time. Some managers may even be tempted to remain overweight because of the returns they are seeing, particularly when some WGBI bonds are offering negative yields.
The general view, however, is that falling out of the WGBI will in itself only have a small and relatively short-lived impact on local bond yields. It will push them higher, but there will almost certainly be enough appetite among local asset managers to buy whatever foreigners have to sell. There may be a more sizeable impact on the rand, however, as foreigners have to translate whatever they sell into other currencies and that won’t be as easily absorbed.
The greater risk, however, is that the South African 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, South Africa is facing multiple downgrades. And that will have much more meaningful implications for the market.