Failure by the government to take the necessary action to reverse the “terrible” loss of confidence in financial markets could lead to catastrophe, says Victor Mphaphuli, head of fixed income at Stanlib, South Africa’s largest fixed income manager.
The clearest indication of this loss of confidence is last month’s financial stability review by the Reserve Bank, which shows the extent to which foreign investors have dumped South African government bonds over the past five years.
According to the review, their share of government bonds has fallen from more than 40% in 2019 to 25%, a sell-off the Bank describes as “a significant structural shift”.
Mphaphuli says it is nothing less than “terrible”.
“South Africa needs these foreign flows to fund our budget deficits. When your savings rate is low it means private investment into the economy is low. We need foreign flows to plug the gap that we are not able to fill.”
Concerns have been expressed, not least by the Bank, about the appetite and capacity of local investors to absorb more government debt as foreign investors flee.
The appetite is still there, says Mphaphuli. “But [investors] want to feel that their investment makes sense going forward, that the country is going to be able to sustain itself in terms of repayment of debt in future. I don’t think local investors are yet factoring in a very high probability of a default.”
Although demand at the Treasury’s weekly bond auctions is declining, he doesn’t think local investors “have reached the stage yet where they will simply walk away from South African debt”.
“If that were to happen then the probability of a sovereign d efault would increase and then it doesn’t make sense to hold the debt at all.”
He has skin in the game — 20% of Stanlib’s R263bn in fixed income assets under management comprises government bonds. “If one doesn’t think a default is imminent, then those bonds look very attractive.”
Doesn’t the fact that South African financial markets are absorbing government debt at higher and higher prices raise questions about the government’s capacity to finance its debt?
It certainly puts pressure on the government, he says. “This is why government has to do the right thing, because we can’t just keep on borrowing, funding our deficits through debt. That is clearly unsustainable.”
Mphaphuli points out that within a decade South Africa has moved from a 27% debt-to-GDP ratio to about 74% now, with the IMF reckoning it will go beyond 80%.
“What needs to happen is that the government must implement the reforms it has promised. The only sustainable way out of this situation for South Africa is by growing the economy. Only then can you grow the tax base and grow revenue so your debt-to-GDP can start getting better.
“We’re in a situation where expenditure is increasing but revenue has basically disappeared as corporates struggle to grow.”
All eyes are on the medium-term budget policy statement in November to see if finance minister Enoch Godongwana sticks to his fiscal austerity line. Is Mphaphuli concerned he will blink?
“He’s got good intentions but there are things that could be beyond his control. The political pressure on him is always concerning, especially when heading into an election year.
For me the biggest risk to South Africa’s budget now, over and above expenditure, which you can control, is the revenue side. And unfortunately, that depends on government implementing the policies and reforms it has promised
“For me the biggest risk to South Africa’s budget now, over and above expenditure, which you can control, is the revenue side. And unfortunately, that depends on government implementing the policies and reforms it has promised.”
If this doesn’t happen, or doesn’t happen fast enough, it will have a “devastating” impact on investment.
“Investment is a confidence game. Investors are looking for an environment where they can put their investments and get good returns and get their capital back. The quickest and only way the government can safeguard that is by implementing the reforms it has talked about in order to increase GDP.”
Corporates in South Africa are sitting on a lot of cash, he says.
“Cash is waiting to be invested. But then you need a good investment environment. We don’t have a choice but to get on with implementing those reforms. If we don’t, then the markets might lose confidence in South Africa and that could be a catastrophe for the country.
“The government has been making all these promises for a number of years and we need to see incremental implementation of those promises.”
Does the government fully understand the consequences if this doesn’t happen and foreign investors continue to dump government bonds, joined by local investors?
“I think the National Treasury gets it.”
He’s not sure about other departments or ministers.
We need to get to that stage where we just do what is needed to grow the economy and not let politics get in the way. I’m looking for the government to do the right thing, regardless of whether there are elections or not
“I’m not in a position to comment on that, suffice to say I think Treasury is doing its best in a very difficult environment. It is always in the back of my mind as an investor that politics may get in the way. We need to get to that stage where we just do what is needed to grow the economy and not let politics get in the way. I’m looking for the government to do the right thing, regardless of whether there are elections or not.”
The fiscal deterioration cannot be left unattended until after the elections, Mphaphuli says.
“It will just get far worse. If you stop governing because of an election it doesn’t mean your borrowing costs will stop growing. If you dent investor confidence by waiting for elections those costs will rise even faster. You don’t want investors to lose confidence because the most difficult thing is to win that confidence back.
“As an investor I’m looking for a situation where we don’t get into an unaffordable debt spiral.” The only way for the government to avoid that is by doing whatever it takes to facilitate rapid economic growth.
Does he think the government understands how high the risk of sovereign default is if its economic reform programme is not accelerated?
“I would love to think they do, because if they don’t, the alternative is ... Let me just say, not good.”
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