By Jackie Horne
Strong inflows into South African bond markets could be on the verge of reversing as investors start to focus on looming political risk and the threat of a sovereign downgrade to full junk status.
Country experts say December’s election for a new head of the African National Congress (ANC) represents a pivotal juncture for the country, which could either return to a path of strong growth and governance, or continue being dragged down by endemic corruption, known locally as state capture.
One the one side is Cyril Ramaphosa, the ANC’s deputy president and a frequent critic of president Jacob Zuma. On the other is the president’s ex-wife and ally, Nkosazana Dlamini-Zuma.
“I’d like to think the ANC rank and file will come to their senses and give it to Ramaphosa,” said David Hedley, chief economist for Sub-Saharan Africa at the Insitute of International Finance (IIF).
It is a view backed by Viktor Szabo, senior portfolio manager at Aberdeen Asset Management in London. “This really is a watershed moment for South Africa,” he said. “It’ll be a pretty binary outcome for asset classes.”
So far this year, South Africa’s domestic bond market has been a recipient of very strong inflows, totaling SAR68bn ($5.03bn) in the first nine months of the year. September alone recorded inflows of R18bn.
Investors have been attracted by some of the highest yields in the EM universe (8.68% on 10 year government bonds) and prospective yield compression, as the South African Reserve Bank remains in easing mode to stimulate sluggish growth of just 0.3% in 2016.
Investors on the sidelines
But Szabo said Aberdeen recently closed out its slightly long position in domestic government bonds and highlighted investor surveys suggesting other fund mangers are starting to position themselves on the sidelines to wait the volatility out.
This could pose a challenge for the domestic bond market, as its 45% foreign ownership ratio is also one of the highest among emerging market sovereigns.
All eyes are now on Moody’s, the last of the three international ratings agencies to maintain a sovereign investment grade rating. Its annual review falls due in November.
This review will follow the government’s Medium Term Budget Policy Statement on October 25. This will be closely watched to see if the new finance minister, Malusi Gigaba, will move in a more populist direction.
“If Moody’s see the government blowing things out on the fiscal side, that’ll be a red flag,” the IIF’s Hedley said.