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South Africa’s $5bn eurobond is fighting fire with fire

By Xolisa Phillip, in Johannesburg
Posted on Friday, 27 September 2019 11:35

A worker sweeps in front of the Johannesburg Stock Exchange (JSE)
REUTERS/Philimon Bulawayo

The South African government's Tuesday announcement that it has raised $5bn on the eurobond market has received mixed reviews.

  • For starters, the country is paying higher yields than its junk-rated emerging-market peers Brazil and Russia.
  • Its budget projections tabled in February in terms of economic growth, tax collection and inflation were overestimated.
  • Its fiscal position is under increasing pressure.

Money, money, money

Of the $5bn debt: $2bn matures in 2029 and $3bn in 2049. The yield for the 10-year bond is 4.85% and 5.75% for the 30-year bond, according to a National Treasury statement released on Tuesday.

The total debt portfolio is about R3trn ($200bn). Before the issuance of the $5bn, foreign debt, as a proportion of total portfolio, was about 10%.

The value of the $5bn in local currency terms is about R75bn.

Courting the market

Isaah Mhlanga, chief economist at Alexander Forbes, said: “We are possibly number three in terms of offering higher yields in emerging markets.”

South Africa has to have attractive yields to gain investors’ attention and money, “given our fiscal challenges,” Mhlanga points out.

He also notes: “The yields are not out of sync with what you see in comparable economies.”

Grade below peers

Brazil and Russia are rated sub-investment grade, but are paying lower yields than South Africa’s. This defies expectations.

  • “Perhaps that indicates South Africa’s sovereign credit rating is not necessarily at the level where it should be,” Mhlanga explains.
  • “Personally, I hold the view we will see a sovereign credit rating downgrade in 2020. We are also going to see a change in credit outlook from Moody’s on November 1,” he says.

Ratings reality check

Finance minister Tito Mboweni is scheduled to table the medium-term budget policy statement, known as the mini-budget, on 30 October.

Moody’s Investors Service is expected to release a review report of South Africa on 1 November. Moody’s rates the country a rung above sub-investment grade.

S&P Global Ratings and Fitch Ratings have South Africa on sub-investment grade, colloquially referred to as “junk status”.

Numbers mismatch

“In February, we overestimated economic growth, tax buoyancy, inflation and other variables. All those things count against us in terms of a better fiscal trajectory,” says Mhlanga.

If the National Treasury does not announce significant expenditure cuts in the mini-budget and the country has not identified ways to raise tax revenue, it would be plausible for the agencies to assess South Africa’s fiscal position as unsustainable, he contends.

On the expenditure side, the National Treasury instructed all government departments to cut spending by 5% next year, 6% in 2021 and 7% in 2022.

Balancing the books

“But that seems a difficult task because departments are being asked to cut current spending, which includes the wage bill,” Mhlanga said.

  • Unions in the public sector have resisted talk of cutting the state wage bill because of the risks to existing jobs.
  • The state wage bill, which caters for about 1.2m government workers, is one of the biggest and fastest-growing line items of budget expenditure.
  • On the revenue side, corporate profits are declining. That means fewer takings for corporate income tax. Add to that weak household consumption, which poses a problem for value-added tax collection.

The positive developments around the South African Revenue Service (SARS) will enhance revenue collection, but will not solve underperformance, says Mhlanga.

Economy to blame

The issue is a poorly performing economy.

“That is why we will continue to see our debt trajectory increasing because tax revenues are going to underperform, despite the reconstruction of SARS,” says the chief economist.

Elize Kruger, economist at NKC African Economics (NKC), is broadly in agreement with Mhlanga.

“The underperformance of the economy relative to projections in February 2019 will likely result in a notable revenue shortfall, a growing budget deficit and higher government debt levels in 2019-20 and beyond,” Kruger explained in a research note.

Plan needed for SOEs

The increased borrowing is related to state-owned entities (SOEs).

NKC considers this unsustainable, “so we hope to hear a realistic and effective plan to address the fiscal burden related to SOEs in October,” said Kruger.

Growth cure

For Mhlanga, the historical record shows South Africa has run a fiscal deficit since the 1990s and made up for it through borrowing. The exception was the 2007-08 fiscal year, when the country recorded a surplus.

Debt is not an issue per se for the chief economist. What is, though, is a rise in the debt to GDP ratio in the absence of sustainable economic growth in the region of 2% a year.

The lack of growth is symptomatic of the deeper structural issues in the economy. However, if those are addressed, through reforms and raising the levels of investment, that could result in South Africa rewriting its growth narrative.

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