In polite conversation, I get asked this question a lot. Clearly, there’s a lot of concern about whether South Africa will be pushed over the edge.
Here are two observations on that:
- R. W. Johnson seems pretty convinced that the downgrade is now inevitable (and I’ve learned to pay attention to his opinion)*; and
*also, interestingly, he’s not the biggest fan of Finance Minister Pravin Gordhan – mainly because Pravin engaged in a bit of gerrymandering while he was Minister of Cooperative Governance and Traditional Affairs
- National Treasury just did a massive new bond issue.
And it’s the second part that I want to talk about.
To explain, here’s a picture of South Africa’s national debt (as at the end of June 2016, based on data from the Reserve Bank):
So of the R2 trillion in government debt outstanding, only about 10% of that (or R200 billion) is actually denominated in foreign currency. And to be clear, that is what’s most likely to be affected by a downgrade: for rand-denominated bonds, the rand can always be printed; but for the forex-denominated bonds, it’s more tricky. And if the rand is weakened by the downgrade, then the refinancing-risk is even worse.
So here’s that national debt profile again, converted to US dollars at today’s exchange rate (because almost 89% of that foreign debt is denominated in US dollars):
The short summary: there’s about $14.6 billion worth of foreign-denominated government bonds floating around out there.
Or, at least, there was.
On 30 September 2016, South Africa’s National Treasury raised an extra $3 billion. The official wording of the press release:
The Republic of South Africa has successfully placed US$3 billion in new notes maturing in 2028 (12 year) and 2046 (30 year) in the international capital markets through an innovative one-day new issue and tender switch transaction. The amount was made up of approximately US$700 million in a switch and tender offer and approximately US$1.3 billion in new cash on the 12 year tranche bringing it to US$2 billion while US$1 billion in new cash raised in the 2046.
The 12 year bond was priced at a coupon rate of 4.3 per cent (at par value) which represents a spread of 273.8 basis points above the 10-year US Treasury benchmark bond. The 30 year bond was priced at a coupon rate of 5 per cent (at par value) which represents a spread of 271.9 basis points above the 30-year US Treasury benchmark bond.
The switch and tender offer was open to holders of the existing 2019 and 2020 maturities with an option to tender for cash or switch into the new 12 year tranche. The reason for the switch and tender offer is to allow the Republic of South Africa to pre-emptively manage refinancing risk resulting from upcoming redemptions of the bonds in 2019/2020, whilst offering investors the opportunity to adjust their portfolio exposures by switching into new longer duration bonds.
The transactions were more than two and a half times oversubscribed in aggregate with investor demand from across all the major centres in Asia, Europe and the United States. The South African government sees the success of the transaction as an expression of investor confidence in the country’s sound macro-economic policy framework and prudent fiscal management.
- “$3 billion” was raised (more than a fifth of the current foreign-denominated debt); but
- $700 million was swapping out foreign-denominated bonds that are due to be redeemed in 2019 and 2020, for longer term bonds to be redeemed in 2028.
The important phrase: “to pre-emptively manage refinancing risk resulting from upcoming redemptions of the bonds in 2019/2020”.
My question: how concerned should we be that the National Treasury is concerned about re-financing bonds in three/four years’ time?
Sure, it’s good timing in general. As Bloomberg tells me:
“South Africa achieved its lowest borrowing costs yet for dollar-denominated debt, taking advantage of demand for emerging-market debt…”
But it does seem like remarkably good timing for other reasons as well.
And it looks a lot like the kind of thing that one would be doing in anticipation of a period of
junk status ‘increased refinancing risk’.