Why South Africa is a waiting game Why South Africa is a waiting game Why South Africa is a waiting game

Why South Africa is a waiting game

Bonds 6 minutes to read
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  Although current market conditions provide relatively uninspiring opportunities for bond investors, looking further ahead, there may be pickings in South Africa’s sovereigns, but here, caution is the watchword.


The January rally took away most of the interesting fixed income opportunities that we identified at the beginning of the year. In Europe, for example, after the Itraxx crossover touched a 3-year high at 373bps at the beginning of the year it quickly retreated to 309bps just one month later. Similarly, in the United States, the high yield credit default swap index also touched a 3-year high at 484bps at the end of December and retreated quickly to 362bps after the Fed’s policy-setting in January.

The rally did not just involve high yield corporates –many investors grasped opportunities within the investment grade and the emerging markets spaces too. Those who were not able to take advantage of higher credit spreads at the beginning of the year were left empty handed and now wonder whether the only thing to do is to accept current prices or to wait for another episode of volatility that would reprice some of the assets.

Forecasting the future is a difficult and imprecise science, therefore the only option left for investors is to keep looking for higher yields, perhaps considering some more speculative opportunities. Within this context, South Africa may be the risky but potentially rewarding target that investors have sought.

South Africa offers one of the highest yielding sovereign bonds in the world. The benchmark South African bond with December 2026 maturity (ZAG000016320) is yielding approximately 8.7%. At the same time, the south African rand is extremely weak compared to its historical averages and there are signs that the political uncertainty and volatility that we experienced under the leadership of President Zuma will soon come to an end thanks to the new government that is more conscious about the challenges the country is facing.

Cyril Ramaphosa became president of the African National Congress, the country’s most powerful political bloc in December 2017 and subsequently replaced Zuma as the country’s president in an unopposed selection process upon the latter’s resignation. 

 Ramaphosa will spearhead the ANC’s campaign in the national elections in May this year, also seeking to consolidate his authority and his party’s leading position. Although these elections constitute an uncertainty for investors, it looks like the ANC is pulling out all the stops to have their man re-elected.

Ramaphosa using last week’s State of the Nation address as a propaganda opportunity in order to show the whole world that he understands where risks and opportunities lie, touching on the most sensitive political topics at the moment. First, he made clear that he has a plan in place to enhance south Africa’s economy: he wants to focus on promoting a business-friendly environment for investors and he wants to restructure state owned enterprises, in particular the Eskom electricity public utility in order to avoid a systemic economic problem. Also, the president reinforced the message that he will not protect the ANC from corruption charges and that he’s committed to eradicating corruption from politics completely.

Ramaphosa’s address at the SONA underlines his commitment to changing the ills and inequities of Zuma’s presidency. However, in terms of winning the elections, this speech raises a few questions:

1: In the case of Eskom, will he be able to make the necessary reforms in order to restructure the company without losing the support of Cosatu, the South African trade union federation? It is hard to give an estimate of the power of unions among citizens, but in the past they have proven to be a deciding factor in politics, and Ramaphosa may need their support in the elections.

2: Will the ANC itself survive the corruption scandal? Angelo Agrizzi, a former executive of services company Bosasa, has testified that the company had paid hefty amounts of bribes to ANC officials over the years.


Although the results of the elections far from certain, opposition parties such as the Democratic Alliance and the Economic Freedom Fighters are having their own issues in their campaign and at the moment, it seems that the ANC is playing all the right cards to stay at the power.

If the ANC wins the election in May we can expect South African bonds as well as the south African rand will rally because it seems that change under Ramaphosa is both possible and concrete. We must remember that the bulk of South African sovereign bonds are held by international investors. As Ramaphosa’s ANC is seen as conscious of the economic challenges ahead and is willing to address them, its re-election in May would likely trigger stronger demand from foreign investors.

But what a re-election of Ramaphosa does not solve is the structural challenges that the country is facing due to the huge debt burden of Eskom. More than 60% of Eskom debt is state guaranteed, and since the company is running with costs related to debt servicing close to two times its EBITDA, and interest payments on its debt consume almost all its earnings, it is safe to say that the company is very close to bankruptcy. This leave very few restructuring solutions to the South African government besides a write-down of debt or a decrease of interest payments. Unfortunately, these actions would take a toll on government funding costs and probably would trigger further rating downgrades, especially from Moody’s which is the only rating agency to have kept the country in investment grade territory.

This is why we believe that although South African sovereigns may represent an opportunity in light of the elections of May, it is important to wait for further details from the current government regarding the restructuring of Eskom. Until this point is clear, it will be impossible to say whether the government has a concrete plan that would isolate Eskom’s issues from the country’s sovereigns.

And as experience teaches it is better to be patient and enter in the market at the right time rather than rushing in and realising too late that higher yield is also a reflection of higher risk.
 
Source: Bloomberg

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo Markets
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets UK Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992