In 2020 and early 2021 there was a fevered debate in bank boardrooms and among asset managers about SA falling over the fiscal cliff edge.
While at the time the Reserve Bank’s “not quantitative easing” bond-buying programme had been only brief around the second quarter of 2020, it had a lasting effect on narrowing from the extreme peak the spread of yields at which you can buy and sell bonds. However, the very large gross financing requirements that the Treasury had to fulfil were spiking from R416bn in 2019/20 to R618bn in 2020/21, and yields were still high and climbing.
Average weekly issuance of local currency bonds had to jump to R6.6bn — and with it discussions of SA needing to go to the IMF. Not for the ultralight facility it ended up getting, but a proper full programme instead — with full-whack conditionality.
A commodity cycle luckily intervened and saved the day, enabling a build-up of cash that could be used in the following years (this year especially where about R100bn of cash will be used), and allowed issuance of local currency bonds to fall back to about R3.9bn a week in the following three fiscal years. The immediate concerns of going over the cliff receded — not totally, but into the long run.
First, the marginal rate at which the Treasury can issue long debt is about 150 basis points (bps) higher now than it was then, while the rate it can issue short bills is (compared with pre-Covid) about 50 bps higher, and versus the lows of Covid, about 500bp higher. As a result, the debt service bill is steadily rising each year.
The rise in T-bill issuance is reinforcing this. The Treasury is having to issue R14.8bn a week now versus closer to R9bn before Covid. Switch auctions have been largely unsuccessful, though the Treasury has managed to expand and diversify the pool of debt it issues with floating rate notes. However, this has not been as much as hoped for, with an expected sukuk issuance also having a shaky road up to this point.
The point is that the Treasury is firing on all cylinders in trying to raise debt, but the steep yield curve limits this (investors demand longer bonds as much as the Treasury wants more mid-curve bonds). And there is only so much they can raise from international financial institutions like the World Bank (though a large Development Policy Operation loan from the World Bank and others with minimal conditionality will drive home the stark contrast to before Covid, when the Treasury was allergic to any international finance institution financing).
The signalling mechanism of higher yields here, as well as a decline in bond market liquidity, shows the market is on edge. After using R100bn of cash this year, there is much less to use in future years, while the gross financing requirement is expected to remain well north of R600bn next year. This is even before we consider a forthcoming very large Transnet bailout. (A forthcoming redemption of Transnet debt on November 6 is proving exceptionally hairy and requiring a game of chicken between the Treasury and banks given that Transnet does not have access to markets.)
Markets have been pushing yields higher because they expect an increase in bond issuance, with much less cash now available to use next year, even after all the trimming the Treasury might do in the medium-term budget policy statement (MTBPS).
There are some minor disagreements on timing, but if we are going to be facing R4.5bn a week issuance at some point soon, it will test the limits of markets as foreigners don’t contribute and domestic savings rates remain very low. Also, they are not rising even in a higher interest rate environment given wider economic and especially labour market pressure. Meanwhile, pension funds and other domestic investors have wanted to shift more money offshore and are demanding higher yields for compensation onshore. (This is partly due to the shift in exchange controls, though most people overplay the effect this has had.)
There is a bigger and much more serious problem brewing. Many entities, like banks and insurers, have to buy and hold bonds for regulatory reasons. Yet they are increasingly unhappy at doing so. This is the so-called bank/insurer sovereign nexus that the Reserve Bank often bangs on about. As banks and insurers become more concerned about the state of the fiscus, the state of the bond market and the fact that bonds will decline in value (even if they don’t have to mark them to market), so they stop buying more than they have to, and those bonds they do have to buy they buy more erratically and demand higher yields. This is the sort of environment in which failed auctions happen.
We are not quite there but we should be under no illusion that a step-up in issuance might severely test this. The Bank will not be there to be the magic money tree. Whether one thinks this is right or wrong, the current leadership nor any likely future leadership of the Bank would do so.
We are therefore left with everyone being unhappy: the Treasury not able to issue as much as it wants, markets unhappy at poor liquidity, banks and insurers having to buy paper they don’t really want to.
The more pernicious effect though is the crowding-out effect. Some people don’t seem to think this exists, but I would say listen to any discussion in a bank annual report and results presentation or listen to renewable projects and business investment discussions. Crowding out is not some theoretical idea but the bread and butter of concerned financial sector leaders and investors.
Banks do not have the luxury that the Institute for Economic Justice (IEJ) seems to posit of simply printing unlimited amounts of new money. As regulated entities, they must hold capital against it and within certain regulated limits. The cost of this process goes up in a highly steep yield curve environment and this is what crowding out ends up being about. Banks are not a magic money tree.
In addition, the steepness of the yield curve makes the break-even rates of projects higher and the internal maths of things like tariff calculations move higher, and so layers additional costs into the economy. As such, it has an additional effect on the demand side of credit.
This is already happening. And it has much to do with the yield curve and the rate of bond issuance and less with comparative headline debt numbers that our (newly) neoliberal IEJ friends seem to think it does.
As such, we are back to where we were in Covid. Discussions abound about how markets function, what happens if we go over the fiscal cliff, if the IMF will eventually need to come in. In the interim, we need to think about the implications of all this. It is not simply about whether the Treasury can issue; it is what they can, at what price, with what liquidity and functioning in the market, and what consequences this has for the wider economy.
• Peter Attard Montalto leads on political economy, markets and the just energy transition at Krutham (formerly known as Intellidex), an SA research-led consulting company.
This article first appeared in Business Day.