Finance minister Enoch Godongwana’s medium-term budget policy statement has set the scene for a two-to-three- year rally in SA bonds, which could enjoy additional impetus from a potential end to the current cycle of global monetary tightening as soon as mid-2023.
That’s the view of two of SA’s most prominent asset managers — Ninety One and Momentum Metropolitan — who both say a likely recovery in the SA bond market in 2023, coupled with a possible pivot from the US Federal Reserve, could potentially set the scene for foreign investors to return to local government debt. That would snap almost five successive years of net sales of local bonds by offshore investors, which Bloomberg data shows totalled a staggering R396.83bn.
However, thanks to the dramatically improved debt projections unveiled in the medium-term budget policy statement (MTBPS) SA’s consolidated budget deficit is now expected to fall to 4.9% of GDP for the fiscal year to end-March 2023, well below the 6% forecast in February’s budget. More importantly, gross debt is now forecast to stabilise to 71.4% of GDP in the 2022/2023 fiscal year before declining further.
That’s markedly better — and two years earlier — than the government’s previous estimate that its debt load would stabilise at 75% of GDP in 2024/2025. It’s also a far cry from reports that emerged in mid-2020 of an internal Treasury document presented to then finance minister Tito Mboweni indicating that SA’s gross debt could surpass 100% of GDP by 2024/2025 and surge to as high as 114% by 2028/2029.
“It was a decent budget given the constraints government is dealing with. The bond market liked the fact that the borrowing requirements came down and that debt levels will stabilise at much better levels than previously forecast,” said Ian Scott, head of fixed income at Momentum Investments. “On a risk-adjusted basis I think SA bonds are one of the best asset classes out there. There’s a very good opportunity for good real returns from SA bonds over the next two to three years.”
The main premise of Scott’s argument is that with SA inflation expected to average 5%-5.5% in 2023, investors who buy SA’s 10-year government bond maturing in March 2032 can lock in real yields of 5.75% to 6.25%, given the security’s nominal yield of about 11.25% at present. The real yield is the difference between the nominal yield (11.25%) and the expected inflation rate, which gives an indication of how much investors can earn from the interest-paying securities after factoring in the effect of inflation.
Malcolm Charles, portfolio manager at Ninety One, says Godongwana’s medium-term budget was “one of the better budget speeches we’ve had in the last 10 years”.
“There’s been good fiscal constraint that juggles what is needed in the short term to get the country working along and importantly some constraint in the longer term to make sure we are sustainable as a country going forward,” he says. “There is some risk in year three but generally it’s a credible budget.”
Charles says international investor perceptions towards SA may also begin to shift after the raft of recent arrests and asset seizures linked to state capture and corruption. He argues that arrests of figures such as Matshela Koko and Brian Molefe and the seizure of Markus Jooste’s assets show the “rule of law is returning”, which along with orthodox fiscal and monetary policy make SA bonds look comparatively more attractive than those of other emerging markets like Turkey or Brazil.
“SA actually now stands out as slightly ahead in the emerging market world,” he says. “For a bond investors a conservative prudent Reserve Bank gives you security that inflation isn’t going to get out of control and as a result, you will be rewarded with real returns from SA government bonds. If you compare the risk vs return of SA bonds the fundamentals definitely favour the return side of the equation.”
Ninety One’s average inflation forecast for 2023 is 5.5% with Charles saying he expects the repo rate to “top out” at 7%-7.5%. Given that the repo rate is at 6.25% that implies at least one more 75 basis point rate hike in November, with the possibility of another of 50 in January.
Both Scott and Charles also expect the Fed to pivot from its aggressive rate hiking cycle sometime between the middle of 2023 and the third quarter of 2023. Charles says that could lure foreign investors back to the SA bond market as they again go in search of higher-yielding assets.
“They won’t be going to Turkey where you’ve got crazy monetary policy or Russia which is under sanctions,” he says. “There are also question marks around Brazil so that really leaves you with SA. If you get that signal from the Fed there’s no reason why SA bonds can’t rally 100 basis points.”
Scott says: “That could provide some interest-rate impetus to the bond market.”
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