In today's episode Warren Ingram and Reza Ismail, Head of Bonds at Prescient , unravel the complexities of global bond markets and South Africa's fiscal landscape. We'll dissect the country's debt handling post-budget, the challenges facing its bond market, and the broader implications of U.S. monetary policy.
Have a question for Warren? Don't forget to voice note your questions through our WhatsApp chat on (+27)79 807 8162 and you could be featured in one of our episodes. Follow us on Twitter, LinkedIn and subscribe to our YouTube channel for more Financial Freedom content: @HonestMoneyPod
In today's episode Warren Ingram and Reza Ismail, Head of Bonds at Prescient , unravel the complexities of global bond markets and South Africa's fiscal landscape. We'll dissect the country's debt handling post-budget, the challenges facing its bond market, and the broader implications of U.S. monetary policy.
Have a question for Warren? Don't forget to voice note your questions through our WhatsApp chat on (+27)79 807 8162 and you could be featured in one of our episodes. Follow us on Twitter, LinkedIn and subscribe to our YouTube channel for more Financial Freedom content: @HonestMoneyPod
brought to you by Pressient Investment Management. Informed by science, guided by insight. Pressient Investment Management is an authorized FSP.
Speaker 2:Welcome to Honest Money. We're doing something slightly different today because we've just come out of the medium term budget and I'll get into that in a bit more detail now and it's kind of a seminal time for South Africa because there's a lot of questions about the South African bond market, about the ability of the country to handle debt, and especially that this debt kind of seems to be spiraling and it's causing a lot of fear amongst South African and international investors. And so I think it's important, between the October kind of medium term budget as well as the Feb 2024 actual big budget, that we see what's going on, and this is not my era of expertise. So I'm very relieved and very happy to have Riza Ismail, who's the head of bonds at Pressient Investment Management. Riza, thanks so much for joining us.
Speaker 3:Thank you very much, warren. Always a pleasure, glad to be on the show, as always.
Speaker 2:So, riza, the ability of a country to raise money, to get money and to borrow money maybe is the simpler way of saying it and then use that money, hopefully to run the country and to grow. The country is done primarily through bonds, but we don't really talk about bonds a lot in investment markets and, frankly, I think a lot of financial planners and people who look at shares don't really understand bonds. So I think for our listeners, let's just start with that. What are bonds?
Speaker 3:Sure, warren. So bonds occupy, if we can think of, different type of investments that carry with it different kind of risk return characteristics. So, for example, if we think like something like a cash investment or money that you put on deposit, it's very safe, there's not a lot of capital fluctuation, it's a low volatility kind of solution, but the returns are also commensurate with that being so low in terms of volatility terms and the fact that your capital is not really at risk. That would be a cash investment. On the other side of the spectrum, I think you mentioned something like a stock or an equity investment.
Speaker 3:So this is something where the prospect of getting quite an outsized gain or sort of an outsize reward is always there. But what comes part and parcel with that is you have to be able to accept and stomach a degree of volatility or fluctuations in the capital value of your investment. So bonds basically straddle those two worlds in some sense. So they occupy almost an intermediate space between sort of cash investments which are sort of low return, low volatility, or, shall I say, less exciting return, low volatility, and a fairly racy world of equities. Bonds basically sit somewhere in between. So you have the prospect there of both almost like an income, like return, like what you get on cash, and also you also do have the prospect of capital gains, something that they borrow, sort of from the equity world. So it's an investment that aims to give you a somewhat intermediate kind of return for an intermediate kind of volatility that sits between cash and an equity investment. That's what it is at its very basic level.
Speaker 2:So if I'm buying bonds, I'm hoping to get a bit of a higher return than I would if I put my money on fixed deposit, and a bit more risk On the other side. If I'm a share investor and I buy bonds, what I'm expecting is that it's hopefully not so volatile, not so rocky, and maybe the price for that is that I don't get as much total return. So and I think that's an important point there that then I would get from the stock market, but hopefully that actually what you really want to do is put the two together. You want all three, right. You want some cash, some bonds, some shares.
Speaker 3:Exactly, that's absolutely right and that would be referred to in common parlance as sort of a balanced portfolio or a balanced solution or a diversified portfolio. We generally have some proportion of equities, some proportion of bonds and some proportion of cash, and maybe we can even extend this to those same asset classes also find a voice in the offshore space, so you can also talk about offshore equities, offshore bonds and offshore cash investments. But generally, yes, that is the idea to blend these asset classes together and effectively get an offering that is hopefully able to navigate different types of market regimes whilst, in the long run, delivering a fairly stable kind of return signature. That is the idea, exactly as you've expressed.
Speaker 2:So now we're in a world where international investors typically look at South Africa's bond market and they would say it pays a better rate of interest on the bonds than they could get, for example, on American bonds or Swiss bonds or something like that. So it can be an attractive place for a bond investor yes, in South Africa, but also globally to look at getting better returns than normal. But that kind of seems to have changed in the last while, where we're not really seeing international buyers coming into the South African bonds as much as they used to, and so the question is what's happening in our bond market that? Are we not generating returns? So when they look at our bond market, what's stopping them buying the bonds that they might have done in the past?
Speaker 3:Yeah, that's an absolutely fantastic question, and I think that the common answer right, or very popular but erroneous answer that we get is that the reasons for that are located in sort of inward-looking reasons, right, in other words, it's because of shortcomings and particular critiques, idiosyncratic reasons that pertain to South Africa itself. Right, that is at the heart of why foreigners are not coming here. This is actually incorrect, okay, and by far the biggest determinant or the biggest reason for why we see this reduced amount of appetite for South African bonds has reasons that are entirely global in nature, right? So you'd remember perhaps in some of your shows, I'm sure you may be covered last year you know this inflationary dynamics in places like the US and then the very aggressive monetary response by the US in an attempt to essentially address inflation, right? So what has in fact happened, warren, is that, in the process of trying to normalize monetary policy in the US right, in other words, in order to hike rates in the US, to restore price stability to the US, what has happened is that short-term rates in the US right have increased quite dramatically, right, and this actually means that there's a heightened opportunity cost for a foreign-based investor or let's just call it a US-based investor to then leave the US right and shun the kind of 5% in USD terms that he could ostensibly get from a US safe haven deposit and instead look outwards towards places like South Africa and Brazil and Mexico, indonesia and Poland and all of these kind of high-carry emerging market destinations. There's no need for that US investor to basically look outwards any longer.
Speaker 3:This is commonly referred to in sort of investment violence as the carry trade. So if you remember, in the period post the global financial crisis, central banks, essentially in places like the US. They reduced policy rates to near zero. Okay. So what that meant was that capital investors could effectively borrow at zero in the US right, take out money at a zero rate of interest and then basically deploy that money in places like South Africa, brazil, russia, in these high-carry emerging market destinations. This was a very popular thing called the carry trade, okay.
Speaker 3:Now, what has now happened was that the entire bedrock of the carry trade has completely been eroded by the fact that it's not zero rates of interest in the US any longer. Right Now, that US guy, if he wants to take out a loan, is basically going to almost have to pay 5% in USD terms or, alternatively, he's faced with the prospect of being able to exploit these very high deposit rates in the US itself. So there's no need for that investor to sort of look outwards towards these high-carry destinations any longer. So what kind of dynamic has by far been the major explainer of why there's been this reduced appetite for South African bonds?
Speaker 3:The challenge, warren, is that unfortunately this happens at a time that is coincident with certain idiosyncratic problems for South Africa on their own. So, for example, reduced appetite by foreigners is also happening at a time that we are also facing quite a large fiscal deficit, that we are also facing large unemployment, that we are also facing load shedding right All these idiosyncratically South African things. That happens to coincide with the time that the global landscape just makes it unviable for foreigners to want to play in South Africa, and unfortunately those two get conflated and people draw the erroneous conclusion that it's because of some SA specific reasons that foreigners are not here.
Speaker 2:So if we were to weight this, we would say kind of 80 or 90% of the thing is that it's global factors and then the last 10 or 20% is South African factors. So if there was a 100 million Rand leaving South Africa, 80 million is leaving because of big factors, 20 million is leaving because of SA factors, and if SA was pumping and our economy was going well and our government was doing the best job they possibly could, we would still then lose 80 million, but not 100 million Absolutely right, absolutely right.
Speaker 2:So I think it's important because when you're talking in my head, what I'm imagining is that that kind of interest rate in America is like a massive, big vacuum clean and what it does is it sucks all the money from the rest of the world and parks it in cash in America because that's perceived to be safe and people don't need to then send money overseas to try and get a bit of a better return, which is perceived to be more risky than what they can put on the deposit in America.
Speaker 3:That's absolutely right. That's absolutely right, and remember that the reason why those rates are so high in the US was because of if we think of the COVID episode right. So the COVID episode was sort of a historically unprecedented level of demand shutdown. I mean, you'd obviously remember the kind of level five type lockdowns we had here in South Africa the streets completely empty, you know, people scurrying around to stock up on toilet rolls and things like that. So COVID was unprecedented.
Speaker 3:The monetary response to COVID, the initial response, ie of cutting rates, was quite unprecedented.
Speaker 3:And then where we are in now circa March of 2022, the pathway out of that COVID response, in other words, the process to now high crates again, that has also been unprecedented in the sense of its scale and its aggressiveness, its level of aggressiveness, particularly in the US right. So now you had a problem where you had elevated inflation in the US right and the US basically having to hike in extremely high levels of increments and at extremely regular pace of increases to deal with inflation right. And in so doing, a byproduct of that monetary response was exactly the phenomenon that I just described a little bit earlier to give rise to that very, very elevated front end of the US yield curve, ie that very, very elevated possibility that you could have 5% or even in excess of 5% in a money market or money market proxy investment in the US right. So it didn't come out of nowhere. It essentially got to that level because of the monetary response, in order to sort of restore price stability or in order to basically get inflation back into kilter in the US.
Speaker 2:And I think it's such a typical of economics right, things happen slowly and then all of a sudden they happen quickly and then everyone's surprised because of the end. But actually the signals were there for quite some time and if we were alive to them we would have known that it was coming. We wouldn't have known when, but we knew it was coming. I think maybe to jump ahead a little bit, so we've just come out of this kind of interim budget I mean, they've got all these funny phrases, treasury for what they do but I always feel like it's the half year budget and then the full year budget happens in February. So we've come through this half year budget in October.
Speaker 2:It's not usually kind of a big event, it's not really something that gets a lot of news. People focus on the February budget. But because South Africa's got some real problems at the moment that are partly self-inflicted, partly global, we're now looking at this interim budget. We did all of us look at it a bit more carefully and I guess one of the questions I had looking at this was kind of are we running out of money? Is this government just spending too much and what are we going to do to stop spending Because in personal finance it's easy, if you're kind of getting to the end of your credit limit, stop spending and you'll be okay. But I don't know, in the context of what's happened in that budget and the signals that we were given for February, is it good news? Are they trying to do things to stop spending or are they just kind of carrying on?
Speaker 3:Sure, and so I probably can identify three separate nuggets or route paths in that question. So I'll try and address all three. So the first one is that South Africa does really have a dire problem with regards to the kind of revenues it generates, or, in other words, which is a function of the kind of real growth path that South Africa is on now. Warren, you'd probably remember that at the time of the February budget this is 2023, the revenue line kind of overshot somewhat, but this was a little bit of false flattery because we know that that was only as a result of, again, somewhat global factors. But there was a massive push globally to this idea of alternative sources of energy and focusing on emissions control and things like that, which then meant that we had a boom in our platinum sector. Remember, platinum group metals, of which we export 70% of the world's production, are used in catalytic converters in vehicles, so it's a means of controlling emissions. So, to the extent that people move towards this very green, very sustainable energy footing, platinum group metals become envolved. So what I'm saying, why I'm saying this, is because the revenue line in February was flattered by the fact that we had a massive run up in commodity prices up to that point, right. What I would say now is that in October, the current November, the current MTBPS, in terms of its undershooting revenue line, is in some sense a far more representative line of the kind of base revenue dynamics here in South Africa that has not been flattered by a boom in commodity prices, okay, and that reality is that we actually sitting with a South African economy that is, in aggregate demand terms, on its knees Okay, we are not nearly generating enough real growth to be able to have debt stabilization a little bit down the line. So what's happening now is that revenues are underperforming and the owners of funding the deficit between revenues and ever expanding Expenses right, as you described it, if you think about it as a household budget kind of thing, you, you almost earning the same type of income, same salary, even perhaps even a little bit of a less salary, but your expenses keep going up, right, so it means that you're gonna basically be using more and more of your overdraft, all right, which at some point needs to be serviced and is and does not come free. Overdrafts are expensive, right, so that onus of funding that overdraft basically falls to the bond market, right, and that is why it gears sharply into focus Every time there's a budget or every time, you know, we discussed that. The medium term budget policy statement, for that matter, is that you generally enter a context of underwhelming revenues, of increasing expenses, and then what to do about the difference? Well, let's turn to the bond market and see if it can sort of bail us out, as it has been doing.
Speaker 3:The problem now, lauren, and linking this back to our previous comments, is that this is also happening at the same time as that. You've got very reduced appetite for South African bonds. So it's all good and well that you know you. The bond market needs to do the heavy lifting in terms of funding that deficit. If there was healthy demand for the bonds, right, if there was a robust local and international demand for South African bonds. But unfortunately we in a situation now where that foreign appetite is simply not there. Okay, so that that is a key thing.
Speaker 3:So it has to get to a stage where structural reforms are Effective that enable us to enter into a better revenue path. That's a B. There has to be some fiscal restraint with regards to, I mean, the Treasury, and a national government cannot continuously sort of appease Labor unions by giving them outsized sort of salary increases, right, which we, which are a natural strain on the budget. So the public wage bill is a major, major sort of elephant in terms of the expense line for a nation's finances, right, and unfortunately we've not seen nearly the kind of restraint that that needs to be there with regards to Expenses. So we have underwhelming revenues, expenses that keep escalating, and again, as I say, the owners of that then falls on the bond market.
Speaker 3:One, one, one minor area of Difference, right, if we, if we again hawk this back to our household analogy, remember that effectively you've got you, let's just say, typical household has a particular level of income and a particular level of expenses, and maybe even your bank allows you a minor level of overdraft, right, so you can spend a little bit more than than what you have to a particular level. But after that it's pretty much came over for an household, right, you know you, there comes a point at which it simply cannot now spend anymore. Right Now, unfortunately and I will use this word very deliberately, unfortunately for a sovereign government, you cannot technically get to a level where you actually do run out of money, right, so, so, so, so. So I mean this is quite a quite a quite a nuanced thing. So what could technically happen, right, is that the government essentially gets money by issuing bonds okay, so it sells the bonds, gets money in Okay.
Speaker 3:But, like we see in very many parts of the developer world, what could very well happen down the line is the government needs more money. There are no buyers for those bonds. They are no, no, no pension funds, no foreigners actually buying those bonds. So what happens is that the central bank itself of that same government our own, our own central bank Will need to buy our own bonds. So one room of the house prints the bonds, another room in the same house buys those same bonds and credits the government's account with a particular amount of reserves, but let's just call it money for ease of explanation. So that is a way that is referred to as debt monetization and that technically means that a country with monetary sovereignty in other words us being South Africa, for example, having our own currency, rands we can't technically run out of rands, right, we can't. That can't technically happen.
Speaker 3:What can very well happen is if this exact dynamic that I'm explaining now I eat debt monetization this whole idea of the central bank buying the bonds of its own country is that you will very likely then have a runaway inflation, right, because the aggregate amount of money that is circulating in the financial system basically goes up.
Speaker 3:Okay, so the problem, in fact, is that you get to a stage where, if nobody wants your bonds, central bank has got to buy it, but because of that, the amount of aggregate liquidity or the amount of money churning around in the financial system increases and you have inflation.
Speaker 3:So that is, in fact, what will become the pervasive problem if we in fact enter into something like a debt spiral where we continuously have to issue more bonds, no buyers, central bank has to bail us out and you will have inflation. So inflation becomes the down the road problem of this idea of a debt spiral, and I'm talking about, you know, at extreme form we get almost like hyperinflation, the kind of things we saw in World War II, germany and, more proximately, what we saw almost like some of the disaster tales in Zimbabwe not too long ago. I'm not saying, warren, that we are anywhere near that. What I am saying is that if this part of, if we cannot achieve fiscal consolidation, these are the moving parts that basically will happen further down the road, right. It's not that you will run out of money like a household, but certain things will need to be put in place that will ultimately result in very, very elevated inflation, and that will not be good news.
Speaker 2:So I think you know, kind of putting it, you know, back into a different context we're looking at, why we're looking at these October and February budgets so much more closely is, you know, we don't expect treasury, we don't expect, you know, the finance minister to grow the country. That's not his job, but what we expect him to do is to enforce discipline on spending. So that that and I think for me that was the kind of the one signal whether we believe it or not is, I guess, the follow up question. But we did see a signal there that they are not, the government is not kind of slacking down on trying to cut the spending or to control the spending and then forcing that kind of discipline. You know, if it hasn't been happening to now which is what I think, what they're saying as well, what treasury saying, then we're going to find new ways to force discipline. So for me that felt like I can't say good news, but it just felt like a good signal to all of us.
Speaker 2:And then you know all this noise and I'm saying noise at the moment because it's not action but the noise around kind of getting transnet right, opening up the ports, getting the railways lines going properly. And then you know, continuing to sort out ESCOM, that's the government's job in terms of trying to get the revenues going, that's part of getting the incoming money better again. They have to do a whole lot more. But gee, I think those are the things when I look at it, that that's why there's so much focus there.
Speaker 2:And the cynic in me, you know, just listening to you now, the kind of the cynic in me is going. I can also understand why there are elements of the ruling party and other parties that are so determined to kill the independence of the Reserve Bank. Because they want the reserve, because if you've got an independent Reserve Bank at some point, they're not going to buy those bonds, they're not going to allow that hyperinflation to happen, and so you need to kill the independence of the Reserve Bank if you want to kind of spend forever. So it again reminds me that you know we need to be ultra village, vigilant that the Reserve Bank stays independent and that they continue to stay in their mandates.
Speaker 3:Yeah, absolutely, warren. I mean like maybe maybe just starting with those, your end comments, maybe just starting with those. I mean, if you remember, not too long ago, in fact, it happened at the wake of COVID. In fact, just a month before that, we received our final downgrade to take us into non-investment grade by Moody's you know, this was circa 2020, maybe a month before the eye of the storm of COVID hit right. And at the time, us in the sort of financial sector we had quite a bit of interaction with the rating agencies, right, and essentially we were quite puzzled in some sense, in the sense that we asked them. You know, the kind of reasons that you are citing for downgrade In South Africa have been known for quite some time.
Speaker 3:So why is it that you took six months to effectively then, you know, do the deed actually pull the trigger and and downgrade South Africa? And we got quite an interesting answer, warren, right, and we, they, they said that look, in terms of your, your, the level of real activity, the level of growth in economy, it's, it's far too pedestrian and but. But this was something we knew. But what is, in fact, a shining grace of South African landscape is the strength of its independent Institutions right, and that is what led to their reluctance to in fact put South Africa in in sort of sub-investment grade, simply because in some sense we would be too strong for that remedial class. Right in some sense on purely on the fact that we've got a very credible and proven reserve bank. On the count of that, we've got a very, very deep and Liquid financial markets with good penetration of our financial sector in our own financial markets. Right, the fact that we've got a Very stable and and mostly reliable judiciary right. So the strength of our institutions, or something that is the only thing that is Allowing us to have some semblance of credibility in the international investor community. They all very well know that there's no growth in South Africa, that there's load shedding, that there's chronic unemployment, that is, many, many social ills, but what they do know is that you've got a tried and twisted and an independent reserve bank. Now, should it come to the stage, to your point, should it come to the stage where that Lost bastion of independence and credibility should get compromised if, for example, people talk about nationalizing a reserve bank, right, I promise you, warren, the kind of the, even the kind of diminished appetite that we've seen for South African investments now, that will dwindle to completely zero. Right, you can, you can, you can. You can. Forget, then, about any foreign and you know interest in South Africa whatsoever if it, if it comes out that that that the central banks integrity has been compromised. So that is one thing that you know, that you know there's a saying in many forms that sometimes it takes basically Maybe 20 years to build a track record of respect and integrity that can disappear in the inner space of a you know, you know an utterance that that takes a mere amount of seconds. You can. You can destroy 20 years of track record with something silly that happens. So I hope that's really not the case here, because, because, as I say that, that is one of the last remaining sort of bastions of, of of excellence that we do have here.
Speaker 3:And then on the on the sort of the government spending side, I mean, yes, there were some green shoots of positivity with regards to. Okay, first of all, let's let's talk about transnet. We know that there was no explicit allocation or no, there was no explicit equity injection that was given to transnet. There was Sort of an announcement that the transnet would need to produce a roadmap, or in other words, they would produce, need to produce a plan that maps out how they would glean efficiencies with regards to everything that they are doing Inefficiently at present. So so we know that there was no explicit money given there. That was a good sign. The market seemed to appreciate that, and there are also other green shoots in place with regards to Requiring sort of fiscal restraint, with regards to curbing back hiring intentions On the part of public offices, which also was some green shoots of optimism. But so that kind of thing needs to increase.
Speaker 3:What was somewhat disappointing was, for example, the extension by another year of the social relief of the stress grant. Remember this was something that was meant to be a temporary, a little bit of a windfall to troubled households in the wake of covid. That was initially extended to 2024, ie going to expire in March of 2024, but now it's been extended to another year, so it's now only will expire in March of 2025. So it's just been pushed, the cans just been kicked down the road, and that that adds, you know, tens of billions to the, to the expense line. You know as well, something that could easily it's quite a thorny issue to try, and, you know sort of excavate yourself from these kind of social transfers because it almost becomes now a public expectation that you do do it right and the risk is that you almost lose your voting base if you now try to Remove that right. But anyway, so that's a thorny issue. So that, unfortunately, is an area that that that we could say there could have been more, more fiscal restraint, but unfortunately didn't quite pan out that way.
Speaker 3:And ultimately, what, what, what do we need to see From the structures that be to get South Africa onto a better growth footing? I mean that that is really the main question. I mean, what? What will it take for us to get back to sort of 2% real growth? And, warren, it's really three things right At the moment.
Speaker 3:Now there's this issue about, um, very, very diminished fixed capital investment.
Speaker 3:The man who owns a pizza factory is not investing capital to build a second pizza factory because he's uncertain Whether he's going to have the kind of electricity stability that he needs to run a plant of that size.
Speaker 3:Right, so, low fixed capital investment, low business confidence and policy uncertainty. So it's that trifecta of things that need to be addressed and without that you really can't get any kind of springboard to to stable real growth and and, and that is the, that is the crux of the matter, even even with a A given amount of debt, which, which I agree, is, is, is, is, is, is somewhat alarming and even though, notwithstanding the comments I made, that you can't run out of money, but the real way to get to debt stabilization is to basically grow the economy right. You need you at some point. You're going to have to have that revenue line that is not chronically underwhelming every single time, but we're getting to a point at which the South African economy is able to actually generate Sort of lost in growth and and, and it's really that thing fixed capital investment, basically policies, the business confidence to return as a function of that and and and getting policy certainty right.
Speaker 2:Reason we I'm going to cut it there because we're we're over time and I think that's a very nice place to To end, because we can see what needs to be done and what we can, what we can watch out for in terms of of policy decisions, that, that, that go for that, and equally, what to watch out for in terms of the negatives. So so I think it's a really good place to go. I think it's our record longest podcast ever, and so thank you so much for your time. It was great, I really enjoyed it and I certainly learned a lot, and we're going to need to touch base again, I think, after the February budget to figure out if things went well. Appreciate it.
Speaker 3:Thank you, Warren.
Speaker 1:Brought to you by prescient investment management, informed by science, guided by insight. Prescient investment management is an authorized fsp.