Foreign investment in South Africa's bond market broke previous records in the first six months of the year, mainly because of the country's pending inclusion in a global bond index. This has important ramifications for both the currency and the fund of infrastructure projects.
Earlier this year it was announced that South Africa would be included in the Citigroup world government bond index in October. Although the country is well represented in many emerging market indices for both equities and bonds, it is the first time it has been included in an index dominated by developed world economies. Following Singapore, Malaysia, Poland and Mexico, it is the fifth emerging market to join the index.
Although South Africa's weighting in the index is relatively small at only 0.44%, it will result in significant inflows and also put South Africa's bond market on the map, according to Stanlib economist Kevin Lings.
"This will make the issuance of bonds easier for the government because there will be a ready appetite for South African bonds. It will also be easier for our parastatals to issue bonds. We will be more closely analysed by foreign investors because they will now have a significant stake in the country and possibly attract new investors who never had exposure to South Africa before," he said.
That it had met the criteria to be included in the index reflected the strong fiscal management of the country, he said, including its credit rating, market capitalisation and the liquidity and general administration of the bond market.
Once South Africa has been formally included in the index, all global bond index tracker funds will have to increase their exposure to South African bonds. It is estimated that this will increase the value of foreign investment to between $4-billion and $7-billion, depending on these funds' current exposure to South African bonds.
What is clear is that many bond managers are increasing their exposure before the formal inclusion. As a result, South Africa has experienced an inflow of more than R50-billion into the bond market over the past six months. In comparison, foreigners invested a total of R37-billion last year, whereas 2010 was a record year with a total inflow of R45-billion, a record that has been broken in just six months.
Lings said although investors searching for investment yield had seen a general increase in bond flows over the past three years, the inclusion of South Africa in the index had mainly driven this year's surge and more inflows were expected during the rest of the year.
These would be long-term holdings – fund managers would hold the bonds to maturity rather than for the short term, which was previously the nature of foreign participation in the bond market, Lings said. This would have a significant impact on the economy.
"Over the last three years, we have seen foreigners start to build long-term positions in South African bonds, where previously it was more opportunistic."
Lings said once foreigners had built up their positions in terms of the index, over the past three years they would have accumulated an estimated R150-billion in South Africa's bond market, a significant portion of which would be long term.
"We should experience less rand volatility as the long-term holdings and constant inflows to maintain the weighting offset short-term reactions to commodity prices or poor economic data," he said.
Because of the demand for South African bonds the yields have come down, which means the government can borrow at lower prices.
Lings said it was an opportune time for South Africa to fund a portion of its planned R840-billion infrastructure projects. Transnet would also be able to use the opportunity to raise funding for its R300-billion infrastructure project. "The cost of funding in both the local and global markets will be cheaper, which creates an opportunity to accelerate the funding schedule," he said.
For South Africa to grow, it has to invest 25% of gross domestic product into growing the economy. Given that savings rates are only just more than 15%, South Africa needs to borrow an estimated R300-billion a year from foreign markets, which means it will continue to rely heavily on global flows. The current inflows will not continue indefinitely and will ease off once the fund managers have reached their weightings. Then the cost of funding will be determined by how South Africa manages the economy.