Former Treasury official Donaldson says Bank can buy up to R20bn of bonds a week

The Reserve Bank should scale up its bond purchases to as much as R20bn a week to help reduce borrowing costs for the government as it seeks to fund emergency measures to deal with the Covid-19 crisis, according to one of the economists briefing advisers and officials in the presidency. 

That would be a major escalation in the use of the Bank’s firepower after deputy governor Fundi Tshazibana told Business Day on April 7 that it had bought about R1bn of government-debt securities the month before, a relatively modest number in a market valued at about R2.5-trillion. The Bank announced its programme on March 25, after identifying market dislocations that pushed bond yields to record highs. 

Such an aggressive show of force, mirroring actions by central banks in developed economies that have exceeded interventions during the great recession a decade ago, would reduce market stress and shift market expectations towards lower long-term yields, according to a paper written for the government by the University of Cape Town’s Andrew Donaldson.

Current shocks to global and domestic demand mean inflation is not an immediate concern despite the sharp depreciation by the rand in 2020, he said. The rand, which started the year at about R14/$, has slid about 25% to nearly R19/$, though the potential effect on inflation has been countered by the collapse of oil prices and economic activity.

Donaldson spent 20 years at the Treasury before retiring in 2017. The group of economists supporting efforts to come up with measures to mitigate the economic impact of the coronavirus outbreak includes another former official, Michael Sachs, who has headed the Treasury’s budget office and is now an adjunct professor at Wits University. Sachs has argued for fiscal stimulus to deal with the health and economic crisis arising from Covid-19.

The Bank, which has slashed its repo rate by 200 basis points in two meetings since March, has resisted pressure to undertake wide-scale money printing to help reduce government borrowing costs at a time when already elevated borrowings costs were raising questions about its ability to fund itself.

The Bank entered the bond market after 10-year yields spiked to close to 13% late in March, though it insisted this was not quantitative easing as it was not meant to influence prices but rather to restore market liquidity and efficiency to ensure sellers could easily find buyers. Yields have since eased back to about 10%, a level that is still seen as severe and unsustainable given that inflation is well within the 3%-6% target range.

After the Bank cut rates on April 14 governor Lesetja Kganyago rejected suggestions that it follow its counterpart in the UK and fund the state directly through so-called monetary financing. That step was unnecessary because the government has no trouble funding itself in open markets, he said. It would also be illegal and in breach of the Bank’s legal mandate.

Even before the coronavirus outbreak government borrowing costs were heading higher due to a weak economy and failure to consolidate spending to arrest a deterioration that was set to push the deficit as a proportion of GDP to close to 7%.

With the economy expected to shrink about 6%, according to the Bank, and the government under pressure to ramp up spending, concern is mounting that capital markets will be unable to absorb increased debt issuance to fund a deficit that some economists said could climb above 10%. That implies much higher borrowing costs for a government that is already spending 15% of its revenue on paying interest. 

Donaldson said international experience showed that to restore order in the markets and reduce borrowing costs, actions by the central bank need to be substantial and pre-announced, to boost confidence and change expectations. Purchases in the region of R10bn and R20bn would represent “a reasonable scale of intervention relative to the temporary income support and health spending needs that the government will have to finance over the weeks or months” of lockdowns and associated measures, he said.

The Bank has said it will not announce the amount of bond purchases it will undertake, nor the time horizon over which it continues with the operations, saying this would be at its discretion and depend on market conditions.