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South Africa: Stretched Western pension funds may yet buy SA debt

By David Whitehouse
Posted on Monday, 19 August 2019 13:44, updated on Tuesday, 20 August 2019 10:21

Early optimism over Cyril Ramaphosa's presidency has faded. REUTERS/Siphiwe Sibeko

The dearth of options available to global investors in government debt may end up working in South Africa’s favour as Moody’s continues to delay action on the country’s last remaining investment-grade rating.

Results from the South African government bond auction on August 6, the first after the treasury said it would raise debt issuance to fund the Eskom bailout, set investor alarm bells ringing.

But lower bid to cover ratios – indicating reduced demand for the securities on offer – are only to be expected when the government increases weekly issues significantly, argues Dirk Steyn, portfolio manager at Mergence Investment Managers in Cape Town. “We are not too worried at this stage as we believe the market would find its level to absorb the new supply.”

Moody’s is the last major ratings agency to rate South African debt at investment grade. “The market has to some extent discounted a downgrade,” says Fabian de Beer, director of investments at Mergence.

  • A Moody’s cut could have a “short term and quite violent negative effect on bond market,” Steyn says.
  • But Mergence believes that the bulk of “steady state downgrade risk has been priced in”, if compared with sub-investment grade peers like Brazil.

Stay of execution

Christopher Marks, head of emerging markets EMEA at Mitsubishi UFJ Financial Group, argues that South Africa is not standing on a cliff edge. He points out that the Moody’s still has a stable outlook on South Africa – there is still an intermediate step available in lowering it.

  • “Moody’s have been very patient with President Cyril Ramaphosa and are doing their best to give him the benefit of the doubt,” he says.
  • “The executioner is not yet coming.”

Rashhad Tayob, a fund manager at Abax Investments in Cape Town, told CNBC Africa that a cut in the outlook may come in November, but that the actual downgrade may not hit until November 2020.

  • “The longer they take to do the downgrade, the less the negative reaction will be,” he said.
  • Ultra-low levels on global government debt, and negative yields on German debt, are a positive for South Africa, Tayob said. Such negative yields are unsustainable for international pension funds as they lock in a loss.

The dilemma facing pension funds in a world of negative yields was highlighted by Charles Gave, founding partner at Gavekal Research, in a research note in July.

  • Pension funds in Europe are warned by regulators not to hold too much cash and are urged to buy more long-dated government bonds.
  • Yet many of those bonds now have negative yields, locking in a loss for future pensioners.
  • If those losses mean that the fund gets closer to being underfunded, then the regulatory answer is clear: buy more negative-yielding government bonds.
  • “The conclusion,” Gave writes, “is that negative rates must eventually destroy the long-term savings industry run by pension funds, banks and insurance firms.”

One way for the industry to survive is to take on more emerging-market debt – including that of South Africa. The market has had ample time to price in the liabilities at Eskom and to adjust to the idea of a sub investment-grade rating.

There is a price for everything, and South Africa 10-year bond yields now approach 9%.

Bottom Line: Moody’s may be able to delay its rating cut longer than pension funds can ignore the South African yields available.

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