markets

Foreigners Can't Resist South African Debt. That's a Problem

Updated on
  • Non-residents own more than half of fixed-rate government debt
  • Nation’s bonds are vulnerable to capital flight: Stanlib

Foreign investors just can’t resist South African bonds -- that should worry policy makers in Africa’s most-industrialized economy.

Non-resident holdings of the country’s debt climbed to 43 percent in March from 41 percent at the end of December, according to National Treasury data. That’s almost double the emerging-market average, according to Goldman Sachs Group Inc. figures.

When it comes to fixed-rate securities, which constitute 82 percent of South Africa’s 1.76 trillion rand ($140 billion) of government bonds, the proportion of foreign ownership is 51 percent.

Rising, rising

Foreign ownership of South African bonds has quadrupled since 2007

Source: National Treasury

2018 holdings as of end-March

“At 30 percent it would be a concern,” said Kevin Lings, the Johannesburg-based chief economist at Stanlib Asset Management Ltd. “At 50 percent it’s a dominant concern. That level of holding does make us very vulnerable if there is an increase in risk aversion. It makes us extra vulnerable to a rating downgrade, if we are ultimately excluded from certain bond indexes.”

South Africa needs the money: it relies on portfolio flows to finance a persistent current-account deficit. What international investors get in return are bonds yields that are among the highest in investment-rated developing nations. But any risk event could turn those inflows into outflows, as this week’s selloff in the nation’s bonds showed.

Non-residents sold a net 7.3 billion rand of South African bonds Wednesday, the most since September 2011. That brought outflows this week to 12.4 billion rand and cut purchases this year to just 4.6 billion rand, according to Johannesburg Stock Exchange numbers. Capital flows into South Africa will probably slow this year, with bond-buying showing the biggest decline, the Institute of International Finance said in a report published on Wednesday.

Forced Sales

South Africa’s local-currency debt escaped a downgrade to junk when Moody’s Investors Service affirmed its Baa3 assessment in March. A cut to sub-investment would see the bonds excluded from gauges including the Citigroup Inc. World Government Bond Index, sparking forced sales of as much as $15 billion, according to estimates by Bank of America Merrill Lynch.

The high level of foreign holdings -- which surged from just 10 percent a little over a decade ago -- is partly a function of South Africa’s sophisticated markets, according to Charles Robertson, the London-based global chief economist at Renaissance Capital Ltd. The presence of domestic pension and mutual funds, which oversee assets roughly the size of the country’s gross domestic product, means there is always a local bid for bonds, he said.

Deep Markets

Local institutions keep bonds well bid

Source: National Treasury

“That means the market is liquid and therefore safer for foreign investors,” Robertson said. “Yes, South Africa has to pay attention to market sentiment, but that applies to local as well as foreign investors.”

Yields on benchmark government bonds fell eight basis points to 8.37 percent on Thursday, declining for the first time in three days as a selloff in emerging-market assets abated.

South Africa’s Treasury said while non-resident holdings are “unusually high,” the probability of a “wholesale exit” by foreign investors is low and the domestic market could absorb any selloff.

“Evidence to date has demonstrated that non-resident holdings are very sticky, and that while they may drop as a percentage of of total holdings, the nominal value remains sticky,” the Treasury said via email. “Further, the ongoing fiscal consolidation will reduce sovereign risks.”

Direct Investment

There’s not much the country can do to limit portfolio-flow volatility, Lings said. Brazil tried, and failed to stabilize its market during the taper tantrum of 2013 by imposing taxes on money flows.

What’s needed, Lings said, is a more stable investment mix including a far larger proportion of foreign direct investment. But for that, President Cyril Ramaphosa’s government would have to improve policy certainty and find ways of stimulating the economy, which is forecast to grow at just 2 percent this year and the next.

“In South Africa, we have gone through a long phase of inflows, but that will change,” Lings said. “We’re not in a position to say we don’t want these flows. We need them to keep the cost of finance acceptable. But I would like to see us trying to diversify those investment sources.”

(Updates with Treasury comment from 11th paragraph.)
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