Bond Market’s Ire Awaits Any Gigaba Missteps on Budget Tightrope

Updated on
  • S. Africa markets brace for minister’s plans to plug funds gap
  • Weaker rand, bonds could hit banks, retailers, property stocks

Malusi Gigaba at a news conference in Pretoria, South Africa, after he was announced as the new finance minister by president Jacob Zuma, Friday, March 31, 2017.

With yields among the highest in emerging markets, South Africa’s bond market is already pricing in a lot of bad news. It could get worse if Wednesday’s mid-term budget statement fails to reassure investors about the government’s commitment to fiscal prudence.

Finance Minister Malusi Gigaba faces an estimated revenue shortfall of 40 billion rand ($2.9 billion) as he prepares to brief lawmakers amid a battle for control of the ruling party that’s stoked political uncertainty and deterred hiring and investment. He’ll have to consider cutting spending, raising taxes and selling state assets if he wants to avoid further ratings downgrades that could lead to large outflows from the bond market.

“We would look for how Minister Gigaba intends to project fiscal prudence beyond the current fiscal year,” Standard Bank Group Ltd. strategists led by Walter de Wet wrote in a client note. “Any deviation from the intention, on paper at least, to compress the budget deficit would be punished by both the bond and currency market.”

Yields on the nation’s benchmark bonds due December 2026 have climbed 35 basis points since the beginning of September to 8.85 percent, a three-month high, while the rand weakened 5 percent. Three-month implied volatility for the South African currency against the dollar climbed to 17.6 percent this week, the highest since April, suggesting options traders expect wider price swings in coming months.

While significant fiscal slippage would hit the bond market hardest, stocks could also be in the firing line. Banks, retailers and listed property shares will come under pressure if bond yields rise and the currency weakens, according to Old Mutual Investment Group.

“Investors will be on the lookout for signs of fiscal slippage,” John Orford, a money manager at Old Mutual’s Macrosolutions unit, said by email. Whether the medium-term budget policy statement “provides a positive or negative signal for investors, corporate and consumer sentiment, markets are likely to remain cautious” until the African National Congress’s conference to elect a new leader in December, he said.

Here’s a round-up of other investor and analyst comments on how the markets could react to Gigaba’s budget proposals:

  • Soledad Lopez, an emerging-market strategist at UBS Group AG in New York:
    • “Deteriorating debt dynamics could lead to further rating downgrades; a fall to non-investment grade would likely cause foreign investors to reduce their bond holdings. A more reform-oriented policy would offer scope for some ZAR appreciation, but we remain cautious about this for now.”
    • “South African equities remain expensive amid low earnings growth. We expect volatility to increase close to the ruling party’s year-end leadership elections. Continued rand depreciation will likely see rand hedges benefiting.”
    • On bonds, “we are underweight given the country’s weak growth, fiscal and political outlook.”
  • Wayne McCurrie, portfolio manager at Ashburton Investments Management, the money managing unit of Africa’s biggest bank by value:
    • “This is probably the toughest set of fiscal conditions that we’ve had since 1994,” when South Africa held its first democratic elections.
    • “While it’s going be a bad medium-term budget plan, everyone’s expecting it, so there shouldn’t be any surprises for anyone. In fact, the only surprise will be where does he raise the tax from.”
    • On the potential disposal of government assets, McCurrie says the stake in Telkom SA SOC Ltd. could be sold. “Telkom itself issued a cautionary saying that their stake might be up for sale and then issued another cautionary saying ‘don’t worry about it, our stake is no longer up for sale,’ so maybe the government changed their mind on that one -- we simply don’t know.”
  • Reyneke van Wyk, head of investment management at Stonehage Fleming Investment Management:
    • There are questions around the contingent liabilities linked to state-owned carrier South African Airways SOC Ltd. and power utility Eskom Holdings SOC Ltd. “Some investors are getting a little bit concerned.”
    • “There are some concerns that if the medium-term budget is not viewed favorably by the markets, then we might see a weakening in the rand, but then again some of that might be priced in already.”
    • “The market will be seeking clear guidance on the implementation of the National Development Plan to grow the economy, create the necessary jobs and ensure the required fiscal discipline, especially with regard to SAA and the contingent liabilities as far as other state-owned enterprises go.”
  • John Cairns, a currency strategist at Rand Merchant Bank in Johannesburg:
    • “We expect a terrible budget on Wednesday -- simply put, there are no more rabbits to pull out of the hat.”
    • A widening budget deficit would see “credit rating agencies raise concerns, but we do not think they will lower the credit rating before the end of the year. They will likely wait for the announcement of tax revenue raising measures, which are typically in the February Budget Review.” 
  • Gina Schoeman, South African economist at Citigroup, says by email:
    • Looking for a realistic macro outlook: “nominal GDP growth assumptions well above 8% and tax buoyancy assumptions well over 1 are seen as unachievable.”
    • Explicit revenue options: “What should we be prepared for in 2018?”
    • Need to see a strong stand against an overly high public sector wage settlement
    • On state-owned enterprises, “SAA is now a yardstick for what is possible with other SOEs -- the market expects something quite strong on this.”

— With assistance by Robert Brand

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