On Wednesday morning the South African Reserve Bank (Sarb) announced that it would start to buy government bonds. This is a tactic, known as quantitative easing (QE), that has been used by central banks in the US, Europe and Japan for some time to stimulate their economies.
Until now, however, the Sarb has been reluctant to do this, even in the face of political pressure. ANC Secretary-General Ace Magashule infamously suggested last year that QE should be explored “to make funds available for developmental purposes”.
The Reserve Bank’s decision could therefore appear to be a significant departure from its traditionally conservative stance.
The bigger picture
However, analysts believe it is important to see the Sarb’s move in context. Significantly, it follows last week’s decision by the bank to introduce additional measures to support liquidity in the bond and money markets.
Essentially, the commercial banks did not have, or were not willing to use, the cash necessary to sustain the normal functioning of the bond market. As the primary buyers of government bonds, they play a crucial role in supporting transactions.
“The Sarb realised that there is a liquidity crunch, so it allowed banks to borrow from it at a reduced rate,” explains Ryan van Breda, portfolio manager at Ngwedi Investment Managers. “That was to support money market liquidity.”
These steps alone, however, did not have the desired impact. Bond yields continued to rise, with the yield on 10-year government bonds going as high as 12.35% on Tuesday.
“It’s important to understand that what we’ve seen in financial markets over the last two to three weeks is a liquidity event, not a valuation event,” explains Ian Scott, head of fixed income at Momentum Investments. “So for the South African bond market and the money market, it is far more important that the Sarb injected liquidity than just cut the repo rate. Not that the cut wasn’t the right thing to do, but for the market, liquidity is more important.”
It seems therefore that the Reserve Bank has felt compelled to go a step further and become a participant in the bond market itself.
“The Sarb is saying that the banks don’t have to be the only buyer of bonds,” explains Jonathan Myerson, head of fixed income at Visio Capital. “It will be the buyer of last resort.”
The market reaction was immediately positive. Yields on 10-year government bonds fell for the first time since March 10, retreating to 10.69%.
Where this leads
However, investors are still concerned about what QE could mean for the country. Where central banks have been buying government bonds in developed economies, their intention is to allow the state to expand its spending.
South Africa can hardly afford to do this. Government finances are already stretched, and expectations are that the budget deficit could balloon to as much as 10% of GDP as the economy contracts due to the impacts of Covid-19.
The Sarb’s intention, however, appears to be different. Its objective is not to support additional government spending, but to ensure that the bond market doesn’t freeze up.
“The purchasing of long-term bonds is effectively QE,” explains JP du Plessis, portfolio manager at Laurium Capital. “But this is not necessarily about pumping endless amounts of rands into the system. It is to support the functioning of the government bond market.”
“The first intention is to ensure there is sufficient liquidity and the market doesn’t become dysfunctional, because ultimately National Treasury needs to be able to keep issuing bonds,” he says. “It is important to allow the government to continue borrowing at the rate it was before.”
There are three important factors to consider in this regard. The first is that the Sarb did not specifically state how much it intends to spend on buying bonds. It may, therefore, be a fairly nominal intervention.
“The point here is that they can do a lot by just saying they are going to do it,” says Du Plessis.
“Just the threat could be enough, and certainly it was if you look at how the market reacted.”
Secondly, the Sarb does not want to sit with government bonds on its balance sheet.
“There is no doubt that the size of buying is limited,” Myerson says. “Whatever they buy they are going to have to sell back into the market because they are not going to be able to sit with a balance sheet of government bonds that are very volatile.”
Finally, the Reserve Bank still has a lot of room to move in terms of its primary monetary policy tool, which is the interest rate. Even after dropping the repo rate by 1% last week, it is still at 5.25%. This is high by global standards.
If the Sarb’s intention is to stimulate the economy, it can therefore still drop that a lot further. It is not in the same situation as central banks in developed countries where interest rates are at or near zero, and so QE is the only other option they have.
“I would say that the Sarb injecting liquidity is not entirely QE,” says Van Breda. “What they are exercising here is financial stability.”