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JOHANNESBURG — An unexpected benefit of South Africa’s struggle to retain its investment grade rating is a wider appreciation among its citizens of how global bond markets affect them. With servicing of the national debt costing more than R1bn a day, even small interest rate changes have a major impact on what’s left of the tax collected for investing in priorities like education and health. As a relatively small developing country (under 0.5% of global GDP), SA requires foreign capital to grow its economy and create jobs for an expanding workforce (population growth 1.2% pa). Owners of capital have a whole world to choose from. So like any money lender, the higher SA’s perceived risk, the more interest they will demand. Independent investment analyst Ryk de Klerk, who founded PlexCrown which has been rating SA unit trusts since 2004, takes us on a four decade journey of the country’s risk profile. In this piece which first appeared in Business Report, he offers a financially-based view worth considering before making your cross in tomorrow’s election. – Alec Hogg
By Ryk de Klerk*
Events have always shaped the perceived risk of investing in South Africa by foreigners as well as future economic trends as foreign investment is crucial for the development of the country. It is therefore worthwhile to look at the impact of historical events going into the elections. One of the best indicators of sovereign risk is the yield spread between 10-year government bonds of a country and that of the US.
South Africa’s economic history is characterised by a few distinct eras. During the apartheid era the country was starved of foreign capital. The Sharpeville massacre in 1960 led to a considerable outflow of capital funds as foreign investors exited the country, giving rise to the introduction of blocked rands as proceeds from sales of local securities on the JSE were blocked within South Africa. Foreigners could use their blocked rands to purchase special government non-residential bonds with maturities of 5 years which after holding them for at least 5 years they could remit the proceeds from the country.
The financial rand replaced the blocked rand in 1979 where investments made in SA by foreign investors could only be sold for financial rands and converted to foreign currencies. The blocked rand and financial rand almost always traded at a discount to the commercial or official exchange rate. Foreign investors therefore bought South African assets on the SA exchanges at a discount, except during the gold boom in 1980 when the financial rand traded at a premium.
The effective yield that foreigners got on their government bond investments were therefore higher than what local investors received. The financial rand was briefly abolished in 1983 but re-introduced in 1985 and finally abolished in mid-1995. I have therefore factored the blocked and financial rand discounts to the commercial rand in the calculation of historical yield on SA 10-year government bonds for foreign investors.
Botha’s axing in 1989 saw the yield spread required by foreigners dropping from 18-12% and continued declining after Madiba’s release from prison in 1990. The Boipatong massacre in 1992 and Chris Hani’s assassination in 1993 had a serious impact on foreign investors’ appetite for SA investments.
After the ANC came into power in 1994 the yield spread continued to decline due to the trust and optimism among local and foreign investors as a result of Madiba’s rule. The Asian financial crisis in 1998 cast a shadow on emerging markets and resulted in a sell-off in emerging market bonds.
Post-Mandela: Foreign investor confidence in SA continued to improve over the next 7 years with the yield spread of SA 10-year government bonds to US bonds narrowing to 2% from 9% after Thabo Mbeki took over from Madiba in June 1999. Confidence was driven by the ICT era and China’s resurgence and a healthy appetite for emerging market assets. It was only interrupted by the 9/11 tragedies and the global market crash in 2001/02.
The Zimbabwean crisis in early 2007 upped South Africa’s risk from a foreign investor’s point of view and the global liquidity crisis in 2008 saw heightened risk premiums on emerging market assets.
When Mbeki was axed in September 2008 the risk premium on SA government bonds was 5%. During Pravin Gordhan’s tenure as Finance Minister under Jacob Zuma the yield spread remained in a tight band except for the spike in 2011 at the height of the European debt crisis.
Nhlanhla Nene’s controversial overnight firing by Zuma, the appointment of David van Rooyen and the reappointment of Gordhan in a matter of a few days in December 2015, crashed offshore confidence in SA bonds.
Zuma’s shocking cabinet reshuffling in October 2017 led to a spike in SA bond yields. Cyril Ramaphosa’s victory in the ANC and his subsequent appointment as President of the country cheered investors as the bond yield spread dropped by nearly 150 basis points to 5.5%.
It was short-lived, though. Ramaphosa’s announcement on land expropriation in mid-2018 and Nenegate in October rattled the markets while Eskom’s collapse in the first quarter of this year resulted in a 100 basis point hike in the yield spread to 6.5%.
In February I said that if South Africa does not get it right and suffers further cuts in the country’s credit ratings we may soon end up where Kenya finds itself, meaning a jump of more than 300 basis points in our 10-year government bond yield to 12% plus from the current 9%.
Getting it right means Ramaphosa must be allowed to walk the talk of his state of the nation address, fight populism and implement his reform agenda. I sincerely hope realism will prevail when making your cross.
Cyril Ramaphosa: The Audio Biography
Listen to the story of Cyril Ramaphosa's rise to presidential power, narrated by our very own Alec Hogg.