7 November 2006

South Africa: Growth of Corporate Borrowing Keeps SA's Bond Market Abuzz

Johannesburg — WHAT happens to the bond market when the borrowing requirements of its largest participant shrink severely?

One consequence of the change in government's fiscal stance from running a budget deficit to running a surplus over the next three years is that it creates space for new borrowers, local and foreign, to come to SA's capital markets, continuing a process that is already well under way.

The public sector is still the largest borrower on the Bond Exchange of SA (Besa); but where five years ago government and the parastatals accounted for 93% of the debt in issue, that's now fallen to 73%, reflecting the rapid growth in the corporate debt market in recent years. And this year, for the first time, new issues of corporate debt are running way ahead of new issues of state debt, with corporate issuance forecast to reach a record total of R70bn for the year, nearly 50% up on last year's total.

In a way, the growth of the corporate bond market and the change in the fiscal stance are outcomes of the same set of factors. The deficit reduction drive that began in the late 1990s helped to drive down interest rates, making it more attractive for companies to use debt to finance their activities. And where high levels of government borrowing had tended previously to "crowd out" the private sector, reducing the deficit began to crowd it in, so that the number of corporate issuers on Besa grew from four in 1998 to 57 last year. But, as the makers of the budget have increasingly realised, the deficit reduction drive has a long positive "tail", which is likely to continue to impact the budget for at least the next five years. Not only is the stock of government debt much lower -- net debt is estimated to fall to only 22% of gross domestic product by 2010, from a peak of over 40% in the late 1990s -- but lower interest rates mean it costs much less to service. The medium- term budget shows the cost of state debt will remain static over the next three years. Add that to strong revenue collections, and the result is a budget surplus in fiscal 2007-08, and probably in the two years to follow -- though the national treasury has pencilled in small deficits, that's only because they've (inexplicably) set aside sizeable "contingency reserves" for 2008-09 and 2009-10. As recently as February, the national treasury was projecting modest deficits.

The change in the fiscal stance, then, is quite dramatic -- it's surprising it hasn't attracted more controversy. And the impact on the public-sector borrowing requirement is even more dramatic. Estimates for next year have been cut from R43,5bn to R10,2bn, or only 0,5% of gross domestic product, and if the parastatals are excluded, government will be a net redeemer of debt, not a net borrower, next year. The national treasury is halving the quantity of paper it offers the market at its weekly bond auctions to about R450m. The reduced supply helps support lower bond yields (hence higher bond prices).

And far from being apologetic about starving the market of paper, the treasury is marketing this as an opportunity to "crowd in" new borrowers, particularly from across SA's borders, in line with government's desire to position SA as a regional financial hub for Africa. Though Finance Minister Trevor Manuel announced changes to exchange control regulations to allow "inward listings" in the February 2004 budget, it's taken a while for the regulations to be put in place. Now it's all ready to go and medium-term budget day saw the first such inward listing on Besa, with the Mauritius Commercial Bank's successful placing of R350m of bonds. Treasury head of asset and liability management Phakamani Hadebe talks of a "new stage" in the development of SA's capital markets, with the bond market set to become not just a domestic market but a regional one. Hadebe said five countries from the region were keen to issue South African paper, and hinted that multilateral institutions were looking to issue rand debt. The liquidity of SA's bond market made it a highly attractive emerging-market alternative, he noted -- and indeed, Besa revealed last week that turnover for the first 10 months of this year reached R9,6-trillion, up from R8,1-trillion last year, suggesting the market could be within reach of the 2002 record turnover of R11,6-trillion for 2006.

Besa GM Marilize Petzer confirms that two "supra-nationals", the World Bank and the European Investment Bank, have made inquiries. Development agencies such as these are active in Europe's bond markets and in other emerging markets' bond markets such as Russia's and Mexico's. Their rand exposures are growing as they increase their activities in Africa and it makes sense for them to cover these by raising funds locally in rands. Their paper would probably be picked up, mainly by international emerging markets investors; it would be interesting to see how domestic investors respond. But this kind of cross-border "crowding in" will be slow and is likely to remain only a small part of bond-market activity. More important, perhaps, for government, is that lower central-government borrowing creates space for parastatals and municipalities to go to the market to raise some of the billions needed to fund planned infrastructure investments in coming years. Manuel has said he wants to see municipalities raising as much as R20bn on the market. So far only the City of Johannesburg has made an appearance on Besa; other municipal issuers are still awaited. Parastatals, too, have not been a big presence this year, other than Eskom, which has placed about R5,6bn of its new, very long-dated ES33 bonds.

For the most part, though, it's been corporate borrowers making the running, and in a major way. Securitisation has grown rapidly, as banks have turned to the capital market to fund parts of their rapidly growing home loans and vehicle finance books. The market has also seen larger and more liquid corporate bond issues, notably the R6,3bn of bonds that cellular operator MTN has brought to market this year. In the first three quarters of this year, according to Standard Bank's credit and securitisation quarterly, corporate issuance rose to R52bn, compared to R34bn in the same period last year.

All indications are there's more to come, for the rest of this year and going into next year. So, though government's needs may be paltry, the bond market is thriving.

Joffe is chief leader writer.

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