South African government debt remains a major concern for many people living or investing in SA. Anchor Capital’s Thomas Hendricks attempts to unpack the size, nature, and the impact of government’s debt burden on the country, as well as on individual investors saving in the domestic currency.
National treasury issues debt in terms ranging from 31 days to 30 years. This debt takes the form of nominal domestic rand-denominated debt, inflation-linked domestic rand-denominated debt, treasury bills (for short instruments of one-year or below), and foreign-denominated debt (typically in US dollar). Beyond this, treasury also acts to insure (by way of a government guarantee) some, but not all, debt issued by state-owned enterprises or SOEs. For example, Eskom has both guaranteed and non-guaranteed debt.
Local bond yields remain elevated, and the yield curve remains steep, which implies that longer-term debt draws a higher interest rate. This also means that raising long-dated debt for the SA government is expensive and, conversely, that bonds are offering higher yields to incentivise investors to purchase long-term bonds. Shorter-term debt is substantially lower yielding, for example, the R2023 bond yields 4.4% (maturing in three years), while the R2048 yields an 11.08% return, maturing in 28 years. This means that, for taking on an additional 25-year term, an investor will earn an added 6.68 percentage points in yield.
A real yield refers to the yield-to-inflation relationship. The basic calculation is to take the yield on a bond in domestic currency and subtract the local inflation rate (annualised, year-on-year) from that yield to calculate a real yield. We note that the simple arithmetic mentioned above is in fact only an approximation of the actual real yield but is sufficient in the current context.
Currently, the local inflation rate is in the 3% to 3.5% range, whereas yields range from 3.5% to 11.08%; a positive real yield can thus be achieved across the SA yield curve. Contrast this to the US where the ten-year bond yields 0.9% and inflation most recently printed at 1.2% (thus the real yield is -0.3%). In SA, a ten-year bond yields just shy of 9%, while inflation most recently printed at 3.3%, thus giving an investor a real yield of 5.7%. Significantly positive real yields have typically arisen throughout the emerging-market universe as a country’s fiscal strength has deteriorated. SA’s experience in this regard is like that of many other African nations.
We expect the curve to remain steep and real yields to remain high for as long as it takes treasury to demonstrate fiscal discipline and a consolidation of government’s finances. This is likely to take longer than one year, and thus we foresee the curve remaining steep into 2021 (and probably even beyond).
However, we believe it is unlikely that this will result in such a weight of buyers that the real return materially decreases
The short-end of the government curve is defined by the shortest rate in the market – the repo rate or the rate at which a country’s central bank (in the case of SA, the SA Reserve Bank [SARB]) lends money to commercial banks. The rate is determined by the SARB at its Monetary Policy Committee (MPC) meeting, which takes place every two months, or when required for emergencies.
Currently, SA’s repo rate is 3.5%, with hikes expected by the market, and implied by the SARB’s Quarterly Projection Model (QPM), for the second half of 2021 and continuing into 2022. Government has issued more short-ended debt because of the rate dynamics at play, as indicated earlier. Given the lower yield demanded on short-term debt, government can raise capital more efficiently than by issuing longer-term debt at yields substantially higher (as an example, consider the R2023 vs R2048 comparison discussed earlier) although this does increase the pressure on government to roll the debt in the next couple of years.
The significant supply of short-dated bonds from treasury is also having an impact on the market, pressuring short-dated yields higher. Market expectations of interest-rate hikes next year, coupled with the continued issuance of bonds, will likely see the yield on these bonds continue to drift higher in 2021.
Although we expect inflation will remain low for the foreseeable future, we expect that the gradual upward pressure on short-dated interest rates will see the yields on money market funds and other defensive fixed income investments, improve over 2021.
We highlight that the policies implemented by the SARB and treasury remain orthodox and conservative. We have noted that several of the more populist ideas that were being discussed a year or two ago have been dismissed. As a result, we expect that the policy framework will continue to exert downward pressure on inflation, keeping SA’s real yields attractive for investors.
Thomas Hendricks is an analyst at Anchor Capital.