Global bank praises SA bond market

10 September 2007

Renée Bonorchis

SA’s government bond market is the sixth-most liquid debt market in the world, ahead of the UK, according to a recent report by the Bank for International Settlements (BIS).

The report, which centred on financial stability and the effect of the development of local currency bond markets in emerging market economies, noted SA’s bond market had a turnover ratio comparable to mature markets.

Countries with higher liquidity than SA in their government bond markets included Taiwan, Poland, the US, Chile and Canada.

Garth Greubel, CE of the Bond Exchange of SA (Besa), agreed that the research strengthened the case for SA to open its local debt market to remote access. This means that overseas investors, depending on the model that Besa and the industry chose, would be able to trade directly in SA’s market without going through an intermediary.

Previously, one of the arguments for the opening up of the market was to try to stop liquidity from flowing to London. If SA’s government debt liquidity is seen to be higher than that of the UK’s, then there may be scope for cementing that position.

“Over the past decade the conscious nurturing of local currency debt markets became a major objective of financial policy in many countries ... As a result, emerging economies’ domestic bond markets have grown substantially. The outstanding stock now exceeds $4-trillion, compared with only $1-trillion in the mid-1990s,” the BIS report said.

Further, the likes of rand-denominated bonds in SA had attracted increasing interest from foreign investors. However the BIS noted that the rapid development of these markets might lead to financial instability in some cases. Even though locally denominated bonds did not carry the exchange rate risk that bonds issued in foreign currencies might, defaults had still occurred.

In the past 11 years, since Besa came into being, there have been no local defaults but the likes of Russia have suffered defaults in their bond market.

The BIS said inflation targeting regimes had also helped to grow domestic bond markets and by the second half of 2005 the International Monetary Fund (IMF) had identified 13 emerging market economies that had introduced inflation targeting, with an “important” economy such as SA being one of them.

Other effects of inflation targeting had included the building up of external surpluses, exchange rate flexibility and a steady decline in long-term interest rates. As the BIS pointed out, all of this was helped along by favourable global conditions.

In the past two years, according to the BIS, there has been a significant development in the issuance of bonds denominated in local currency (rand- denominated bonds being an example) in the international markets.

“The single-most important currency of issuance was the South African rand,” said the BIS.

SA was also the largest issuer with $2,1bn of local currency bonds being issued internationally. This says a lot about the perceived stability of the rand and SA.

“By issuing local currency bonds in international markets, sovereign issuers have tried to tap international investors while changing the currency mix of their debt portfolio,” the BIS said.

This year SA has been playing it safe. Just a couple of months ago SA issued a new $1bn dollar-denominated bond at the lowest cost in the country’s history and cut its short-term foreign debt in a buyback to reduce its vulnerability to external shocks.

This was a prescient move in light of the recent market turmoil. But having foreign investors in your market at all can be risky. The bank said when foreign currency debt to foreigners exceeded foreign currency assets, then an exchange rate depreciation would have a negative effect on the country’s wealth.

But having come from a negative position on foreign currency assets in the 1990s, SA now has $28bn in foreign currency assets. Stability is further helped by the fact that SA has no central government debt outstanding.

Stability and liquidity could help to absorb markets stresses, such as we were seeing now with the subprime mortgage problem emanating out of the US. While the spreads on local bonds had widened, turnover was still high. Liquidity, said the bank, was also essential for limiting the financial distortions that increase systemic vulnerability.

Looking at the global market sell-off in May and June last year, the BIS said in many emerging economies the recovery had been relatively rapid.

“Many key markets (such as Brazil and SA) that have often been vulnerable to deterioration in investor sentiment in international markets suffered only temporary dislocations, which could reflect increased resilience to external shocks as well as the rapid recovery of risk appetite globally.”

The development of futures markets, the securitisations industry, a relatively wide and diversified investor base, a large unit trust industry, active pension funds, the growing number of corporate bond issuers and a healthy over-the-counter market had all added to the positive sentiment surrounding SA’s debt markets.

A point of caution: the BIS said government debt spreads were the main determinant of corporate spreads. If the result “extends to other countries, it could be a financial stability concern in situations where sovereign performance is a poor proxy for the corporate sector”.
(Businessday, 10-10-2007)

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