BRIAN KANTOR: Bond yields proof of some minor economic miracles

The update on the budget released on November 12 was well received in the bond, currency and share markets. The yield on the benchmark 10-year RSA bond gained 12 basis points (bp) on the day to continue an extended bull run that started in April, when doubts about the endurance of the government of national unity (GNU) were most pronounced.

The yields on conventional RSA bonds of five-year duration have fallen consistently from more than 9% per annum to 7.8% since April. The republic’s cost of borrowing dollars has fallen even more significantly, from 7.2% a year in April to the current 5.1%, representing a sovereign risk spread of 1.4% and less than half the risk spread of early April.

The difference between RSA and US five-year yields — the carry or cost of hedging dollars over the next five years, equivalent to the compound rate at which the rand is expected to weaken against the dollar over the next five years — has fallen in line, from more than five percentage points to 4.1 percentage points.

The bond market is now factoring in an average rate of inflation of 3.6% over the next five years, down from over 5% inflation expected in April 2025. And the mighty rand has gained about 10% against an equally weighted index of the dollar, euro, Aussie dollar and yuan since April. The GNU has surely produced a kind of very welcome economic magic.

Fiscal reversal

The budget update confirmed that South Africa could reverse unfavourable fiscal trends and contain the growth in government spending, and so avoid monetising the considerable national debt. A further favourable force was that the target for inflation of 3%, while accepted by the Treasury, was helpfully qualified by a one-percentage-point band around 3% and accompanied by a phasing-in period, thereby improving the outlook for lower short-term interest rates and growth.

The GNU can’t claim all the credit, though. The rise in precious metal prices, plus the stability in industrial metal prices, has helped to add to government revenues and improve the balance of trade, further improving the fiscal and growth forecasts this year and the case for South African bonds, the rand and the JSE.

READ IN FULL | Enoch Godongwana’s medium-term budget policy statement

Faster South African growth would be boosted by lower short- and long-term interest rates. There is growth-enhancing scope for declines at both ends of the yield curve should the expected rate of inflation decline further, which it could, but only were the rand to continue to hold its own with its low-inflation trading partners.

The supply side of the South African economy has been boosted by the strength of the rand in a low inflation world. The demand side of the economy has remained depressed by the high cost of bank and other credit. Lower inflation means more expensive credit and less demand for and supply of it from the banking system. Lower short term interest rates would predictably stimulate spending by South African households and firms and raise growth rates.

Would such welcome trends mean more inflation? Not necessarily — inflation in the future would, as in the past, depend on the behaviour of the rand. Faster growth would mean increased demands for imported goods and foreign currency, but it would also simultaneously encourage inflows of foreign capital, including to the bond market, and discourage outflows of South African savings.

The larger deficits on the current account of the balance of payments (extra demand for dollars) would be matched by larger net inflows of foreign capital willing to participate in faster South African growth (additional supplies of dollars). If so, the rand could be well supported and the inflation rate contained. Faster growth with no more inflation is a virtuous cycle that we can only hope will be put to the test over the next few years — Reserve Bank permitting.

Show of commitment

The immediate task for the Treasury is to fulfil its plans for containing government debt. But it should help taxpayers in two further essential ways. First, to show belief in its inflation targets and borrow for shorter rather than longer periods, and roll over short-term debt for longer-term debt as inflation and interest rates recede.

The Treasury’s concern with so-called rollover risk (a possible inability to borrow short to retire longer-term debt) has been an expensive fear, though not shared by the ratings agencies.

Another task for the Treasury, which it has long been aware of but, egregiously, has failed to deal with, is the huge, unaffordable national liabilities of the disgraced Road Accident Fund. Claims on it must become realistic given taxpayers’ limited ability to pay, and the responsibility for insuring against road accidents should be devolved, as with all other insurance, to the private sector.

• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.