Global Investing

South African bond rush

May 10, 2012

It’s been a great year so far for South African bonds. But can it get better?

Ever since Citi announced on April 16 that South African government bonds would join its World Government Bond Index (WGBI),  almost 20 billion rand (over $2.5 billion ) in foreign cash has flooded to the local debt markets in Johannesburg, bringing year-to-date inflows to over 37 billion rand. Last year’s total was 48 billion. Michael Grobler, bond analyst at Johannesburg-based brokerage Afrifocus Securities predicts total 2012 inflows at over 60 billion rand, surpassing the previous 56 billion rand record set in 2o1o:

The assumption..is based on the fact that South Africa will have a much larger and diversified investor base following inclusion in the WGBI expanding beyond the EM debt asset class

Currently South African bonds are restricted to emerging local bond indices. The most-widely used, JPMorgan’s GBI-EM, has less than $200 billion benchmarked to it and South Africa’s weighting is 10 percent. But the WGBI is a different matter altogether — around $2 trillion is estimated to track this index which currently includes just 22 countries, only three of them emerging markets.  An expected 0.44 percent weighting for South Africa implies inflows of  $5-$9 billion, analysts estimate.

Some of that cash has already come. How much more could roll in this year? Optimists point to Mexico – foreign ownership of the local debt market there rose to 31 percent from 24 percent over 2010, the year the country joined the WGBI, with $11 billion flowing in. But the picture in South Africa is in fact not that rosy. Inflows will undoubtedly pick up, benefiting both bonds and the rand but many reckon positioning in South African bonds is already pretty crowded –  about a third of the market is in foreign hands already, analysts at Morgan Stanley reckon. Worse, the country faces a possible credit ratings downgrade this year (all three rating agencies have cut its ratings outlook to negative in recent months).

Kieran Curtis, a fund manager at Aviva Investors upped his holdings of South African local bonds after the WGBI news but is reluctant to go overweight,  betting the market will benefit less than Mexico did two years ago. He cites two reasons — first South Africa’s budget deficit has been creeping higher and it follows that debt issuance will too. Second, the external backdrop is less supportive today than two years ago when the Fed was in full money-printing mode:

I wouldnt say I detect a very strong commitment in South Africa to restoring the budget to balance and those debt numbers can rise quickly when you have a 5-6 percent deficit. Also Mexico’s inclusion came at a time when U.S. Treasury yields were falling fairly quickly but now, with Treasury yields rising we may not get the same support for South Africa.

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