South Africa’s reliance on deep local markets to finance most government borrowing is no longer a given.
Domestic investors are demanding ever-higher yields as foreigners pull back from the market, just as the National Treasury gears up to refinance almost R1 trillion of debt over the next three years.
That’s raised alarm bells at the South African Reserve Bank, which warned last month that the growing reluctance from domestic investors to continue absorbing government issuance could drive borrowing costs even higher.
The average yield for 10-year bonds sold at the government’s weekly auction has climbed to 11.27%, compared with 10.2% five years year ago, according to data compiled by Bloomberg. In that time, domestic funds, banks and insurers absorbed about R2 trillion of government bonds, boosting their share of the debt to 75% from 58%, according to the Treasury data.
“It is difficult to see them absorbing another R1 trillion in the coming three years,” said Rashaad Tayob, the Cape Town-based head of fixed income at Foord Asset Management, whose Abax Balanced Prescient Fund has outperformed nine out of 10 peers over the past three years.
“Allocations to bonds are higher everywhere, and the ability to buy more is constrained.”
South Africa’s borrowing costs have soared
Rising borrowing costs, along with stagnant economic growth, are complicating the government’s pledge to reduce its budget deficit and curb debt.
A R254 billion bailout for state-owned power company Eskom means government debt will probably peak at 73.6% of GDP in fiscal 2026 — a higher level and three years later than previously expected.
Debt-service costs — the fastest-growing expenditure line item for about a decade — will increase to almost 20% of main-budget revenue. Failure to consolidate debt could see the country’s credit rating slide deeper into junk.
Weak demand from foreign investors for new government bond issuance is placing a greater burden on the domestic market, and marks a “structural shift” considering the significant increase in government borrowing over the past five years, the Reserve Bank said in its Financial Stability Review last month.
“It raises concerns about the capacity of South African investors to continue absorbing new issuances of government bonds in future,” the central bank said.
“As local participants increasingly step in to absorb the declining appetite for new issuances by non-residents, this raises financial stability concerns regarding market liquidity, increased volatility and higher domestic government bond yields.”
The government is concerned about outflows from the bond market through the rise in domestic holdings “demonstrates the depth of local financial institutions,” the National Treasury said in an emailed response to Bloomberg’s questions.
It’s considering its funding mix to help limit borrowing costs as debt comes due for redemption.
“Higher interest rates will result in higher debt-service costs and debt levels,” the National Treasury said.
“To mitigate the refinancing risk as a result of high redemptions, the government will determine the best mix of debt instruments and maturities to finance the borrowing requirement while minimizing refinancing risk, currency risk and overall borrowing costs.”
Also contributing to faltering demand from local investors was an amendment last year to prudential rules, allowing pension and mutual funds to invest as much as 45% of their assets abroad, up from 30% previously. That further limits the incentive for local funds to buy domestic bonds, said Foord’s Tayob.
To be sure, demand at the most recent bond auctions has improved as yields near the highest since the pandemic attracted buyers.
Outflows have also eased, with foreign investors net buyers of the bonds to the tune of R3.4 billion last week, according to JSE data.
As inflation moderates and global interest rates stabilize, demand for South Africa’s debt may improve, said Mike Keenan, a fixed-income strategist at Absa Group Ltd.
“Even though the debt pile is high, we believe that National Treasury will continue to service its debt over the coming years, partly because it has become more flexible with its funding mix,” said Keenan, who sees the 10-year yield falling to around 10.8% by year-end, from around 11.89% on Monday.
But any more political upheaval, such as the recent diplomatic spat with the US over South Africa’s alleged arms supplies to Russia, and ongoing economic challenges, including a power crisis and transport hurdles, will keep borrowing costs elevated, said Nishan Maharaj, a portfolio manager at Cape Town-based Coronation Asset Management, which oversees about R623 billion.
“They will be able to refinance. However, the cost of that refinancing will be well above nominal GDP and probably lead to a worsening of the fiscal dynamics,” Maharaj said.
“South African bonds trade at a level that encompasses quite a bit of risk premium. While this might seem excessive, one would expect that risk premium to stay elevated until there are signs of a positive fundamental shift in South Africa’s economic drivers.”