South African Finance Minister Malusi Gigaba took on the bond market, and he is losing.
As investors digested Gigaba’s intention to close a yawning budget gap by flooding the domestic market with an additional 122 billion rand ($8.6 billion) of bonds over the next three years, benchmark yields soared as much as 56 basis points to 9.42 percent, the highest in 19 months. That’s already closing in on the government’s own bad-case scenario of an 80-point jump in yields – and things could get a lot worse.
The market and rating companies “will hate” an increase in the debt ceiling, rising bond issuance, the lack of spending cuts, and the widening deficit contained in the budget proposals, Investec Asset Management said in a note to clients.
Foreign investors, who hold 41 percent of the country’s 1.97 trillion rand of local-currency bonds, dumped 5.1 billion rand of the debt in the hours after Gigaba delivered his medium-term budget statement to lawmakers on Wednesday. That’s the biggest one-day outflow since September 2011, at the height of the European debt crisis — but it’s small compared to what could happen if the debt gets downgraded to junk, forcing South Africa’s exit from Citigroup Inc.’s World Government Bond Index.
That would spark outflows of as much as 200 billion rand as investors that track the index divest their holdings, according to a recent estimate by JPMorgan Chase & Co. If that happens at a time when rising rates in developed nations curb demand for emerging-market assets, yields on benchmark bonds may climb close to 11 percent and stay there, according to the worst-case scenario painted by South Africa’s National Treasury.
“A downgrade and exclusion from the WGBI seems as though it is a foregone conclusion in the market,” Reezwana Sumad, an analyst at Nedbank Group Ltd., said in a client note. In addition, “South Africa’s vulnerability to global and emerging-market risk sentiment cannot be ignored. Any turn in foreign sentiment would yield large outflows from the bond market, and consequently higher yields,” she said.