Wednesday, 10 September 2014 - 20:00

 

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Seed Weekly - A brief overview of South African government debt

When any government spends more on its various departments (such as general public services, health, education, infrastructure etc.) than it receives by way of its taxes, they need to borrow the difference by way of issuing bonds in various forms.

Because the South African government has a long history of running fiscal deficits, it has developed a sophisticated treasury operation which is responsible for the debt management for government amongst other things.

Treasury released its 2013/14 Debt Management Report last month. If one looks at the size of the South African economy, it is approximately R3,5 trillion. The second quarter reflected the economy growing by only 0,6% quarter on quarter (annualized), after declining by the same percentage in the first quarter.

Against this backdrop, the government’s total outstanding debt continues to climb and in the latest report it now stands on a net basis (i.e. after reducing for cash balances) at R1,4 trillion. This level of debt as a percentage of the economy’s GDP is therefore 39,8%. Government was originally budgeting 39% at March 2014.

Because the government’s medium term estimate over the next 3 years is for expenditure to exceed tax revenues by around R430 billion, the only way that this shortfall can be met is for government to borrow more money in the debt market. But just who does it borrow these funds from?

The chart below reflects the various types of lenders that have lent money to the South African government and the change in their ownership from 2008. Seven years ago non-residents owned just 12,8% of all issued government debt. Now they own over 37% of total issued debt.

Holders of government bonds 2008 – March 2014

Local pension funds owned 44% in 2008 but greater foreign participation over these last few years has diluted pension funds to the second biggest holder of debt. The increase in foreign ownership has largely been due to the search for higher yields post the global financial crisis.
Fortunately the local government has very little foreign issued debt. Net of foreign cash holdings it is just R59 billion and just 4% of total net debt.

Naturally as the level of debt increases, as the rand weakens and as interest rates potentially move up as lenders require a greater return for the increased risk, the interest burden on total outstanding debt escalates. Currently the government is spending around R101 billion per annum or 9,6% of government expenditure.

As investors we need to make an assessment of the risk versus potential return of allocating capital to government bonds. Lending capital to a government may be lower risk than lending capital to a company because a government generally has greater ability to borrow and so repay its debt, but it is never risk free. Furthermore globally we have seen governments default on their debt obligations.

On a cursory “top down” view of the risks in investing into government debt, one may want to consider the following:

1. Increasing foreign ownership of local bonds has been positive, but it can quickly turn negative should global interest rates move up and foreign holders turn net sellers.
2. Ongoing fiscal deficits necessitate additional government borrowing. When seen against a generally stalling economy, the total debt to GDP metrics start to make investors nervous.
3. Love them or hate them, rating agencies still carry weight. The South African government has solicited ratings from four major credit rating agencies. Recently however S&P downgraded their rating to BBB - (one notch above speculative or non-investment grade). Fitch retained their BBB rating but changed their outlook from stable to negative. Moodys is still more optimistic and retains Baa1(negative outlook).
These factors all point to the risk that lenders will demand higher yields as risk increases. With bonds, as the yield increases so prices decline, resulting in capital losses for investors. At Seed we remain generally more cautious of the longer term investment outlook for local bonds.

Kind regards

Ian de Lange

www.seedinvestments.co.za
info@seedinvestments.co.za
021 914 4966

Wed, 10 Sep 2014

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