Fed Adds to Gloom Facing South African Debt as Rand Risk Rises

Updated on
  • Zuma's government running out of options as growth stutters
  • Barclays says bond yields may jump to levels seen in 2011

The renewed risk of a U.S. interest-rate increase by the end of this year is adding to home-grown issues weighing on South African bonds, the worst-performing emerging-market debt over the past two weeks.

An index of rand-denominated notes has lost 6.8 percent since national protests started at university campuses on Oct. 19 before spilling into parliament grounds and the lawns in front of the government head office in the capital Pretoria and President Jacob Zuma bowed to demands to freeze fee levels for next year. That’s more than the local currency debt of 31 developing nations, which on average lost 0.8 percent.

The government is running out of options to reignite growth as funding pressures increase. Finance Minister Nhlanhla Nene last week cut his growth forecast for this year to 1.5 percent from 2 percent, while predicting the fiscal deficit will widen and borrowing needs will jump, all raising the threat of a credit downgrade. Back in the mix is the increased chance that the Federal Reserve will boost rates in December, luring investments to dollar assets, hurting the rand in the process and risking higher inflation.

“Risks are to the upside both for the currency and for bond yields,” Mike Keenan, a sub-Saharan strategist at Johannesburg-based Barclays Group Africa Ltd., said by phone. A Fed hike improves “the likelihood that emerging market investors in general are going to require an increased risk premium to be priced into bond yields,” he said.

Yields on government bonds due December 2026 jumped 20 basis points since Oct. 16 to 8.34 percent as of 6:15 p.m. in Johannesburg on Friday. Once the rates break through the 8.60 percent level, they could jump to almost 9 percent by the end of the year if the Fed raises rates, Keenan said. That will be the highest since March 2011.

South Africa faces a “serious struggle” to meet its plan to cut an unemployment rate of 25.5 percent and boost growth, Zuma said in an interview on Oct. 27 that followed the biggest student protests since the end of apartheid.

While the country avoided an immediate credit downgrade, Fitch Ratings and Moody’s Investors Service, which rate the nation’s debt two steps above sub-investment, are set to bring their assessments in line with Standard & Poor’s at the lowest investment-grade level, credit default swaps suggest.

Lack of Clarity

A lack of clarity over how the government will fund Eskom Holdings SOC Ltd., the state-owned power utility, is adding to the country’s woes, said Rune Hejrskov, who helps to oversee $1.3 billion as a senior money manager at Silkeborg, Denmark-based Jyske Bank AS. He has cut his South African bond holdings to neutral from overweight in relation to what bond benchmarks suggest.

“We’d like to see some more stabilization of the both the budget numbers and growth numbers as well some sort of credible plan regarding Eskom before we consider adding to our position,” he said. “The government needs to reform some more to realize an improvement in the budget numbers and we haven’t really seen anything in that regard .”

The rand weakened 5.3 percent against the dollar since Oct. 16, the most among 31 major and emerging market currencies tracked by Bloomberg, and extending its decline in 2015 to 16 percent. The benchmark equities gauge posted its biggest weekly loss this month.

“I’m very concerned about all markets, not only equities but bonds as well,” Abri du Plessis, a Cape Town-based fund manager at Gryphon Asset Management Pty Ltd., said by phone. “For that reason I like to sit on cash and I’ll rather do that for the next six months until there’s more indication where the global economy is going.”