The question at the forefront of our clients’ minds now when they consider fixed-income investment in SA is: “How safe is it to invest in SA government bonds given the current fiscal situation?”. We have considered four different scenarios, which sit on a continuum.
At one end is the high road scenario, in which the government pursues the right policies for economic growth and this creates general prosperity. At the opposite end of the continuum is the failed state, in which the government runs out of money.
In between are two more realistic scenarios, and SA could move between them. One of these is the road to nowhere, which occurs when the government can raise sufficient revenue to cover its costs, takes steps to reduce national expenditure and follows policies that generate slow economic growth. The economy drifts along, not improving or worsening.
In the other plausible scenario the economy also drifts along, but government expenditure exceeds revenue and the country ultimately requires a bailout, accompanied by enforced policy corrections. Though the bailout agency is most likely the IMF, it could also be Russian or Chinese financing.
Each of these scenarios has different watchpoints. For the high road, those are signs that the government is regaining the trust of the population and the private sector. It pursues pro-growth policies and reforms state-owned enterprises (SOEs).
For the road to nowhere scenario, we would be alert to signs that developmental state ideals have trumped reality — that the government takes command of driving economic growth. In this event expenditure comes under control just enough to maintain the status quo and corruption slows.
Populist solutions
For the bailout scenario, we would watch for the fiscus being drained by rescue packages for SOEs (such as SAA) and grants to the unemployed. Corruption remains endemic and costly, and the government eventually runs out of money and decides to seek a bailout.
In the event of a failed state, we would see populist solutions take preference over prudence — for example the government printing money to finance its debt, or taking money from pensions, instituting prescribed assets and defaulting on the national debt.
Each scenario has vastly different implications for asset management. The best strategy for the high road scenario is to buy SA risk assets — equities and bonds — and reduce offshore exposure. In both the road to nowhere and bailout events, the preferred assets would be SA bonds for income and global equity to generate growth. If SA is heading for a failed state, all SA assets should be sold and investors’ money should be 100% offshore.
Putting this into the context of what is happening in SA now, we believe the high road is possible based on positive signs such as the renewable energy tenders, which are a significant step towards fixing energy insecurity, and the government’s newly published National Economic Development Programme. The success of this programme will depend on the details and deadlines. The government has recognised that it no longer has the financial or technical capacity for infrastructure rollout.
Failing SOEs
There are also signs that SA could be on the road to nowhere. Prosecutions for corruption have begun, but not to the extent needed. SAA bailouts continue, which is concerning, and other SOEs continue to beg for more money. The finance ministry’s proposed expenditure cuts look achievable, and we think the government can rein in its spending sufficiently to put the economy on a sustainable path. The biggest remaining challenge is policy disconnect, with conflicting statements from the government.
A worrying indicator that the country could be heading for a bailout is continued state support for failing SOEs. More positively, the government has rejected many populist positions, such as implementing prescribed assets or nationalising the Reserve Bank. But things could change in five years.
We believe the most prudent strategy over the next 12 months is for investors to earn income in Africa and look for growth in global equity. On local equity, we are incrementally more positive than in the past, but not enough to move to a positive overweight at this stage.
We believe the global economy will remain volatile, with second and even third waves of Covid-19 and talk of further shutdowns, but we do not believe it will derail and there may even be interesting buying opportunities. We see the rand recovering to the level of between R15.50/$ and R16/$ as government policies are rand-positive and the dollar could be weaker in the short term.
SA government bonds are yielding 6.3% above domestic inflation, which is one of the most attractive yields available in the emerging-market universe. Foreign participation in our bond market is low, but we think there will be further support.
US 10-year treasuries are below fair value but could be used as a temporary refuge from global equities. A better option for risk-averse investors would be global corporate bonds, which are yielding 2%-3% in dollars.
• Wapenaar is co-chief investment officer at Anchor Capital.
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