If short-term money is so cheap, why is long-term money so expensive? With inflation well under control and the economy crashing, the Reserve Bank cut interest rates yet again this week, which means the benchmark repo rate has dropped from 6.5% at the start of this year to 3.5% — and the prime interest rate, off which banks price overdrafts and other loans, has come down. The last time short-term rates were this low in SA was in the early 1970s. But try to borrow longer term — as the government has to do in large quantities — and it's not a happy picture.
The yield at which the government's 2026 bond is trading in the market, effectively the interest rate it has to pay to get a five-year loan, is 7.5%. That jumps to about 9.2% on the 10-year bond and about 11.5% on the 30-year bond. This is the “exceptionally steep” yield curve the Bank’s monetary policy committee commented on with concern this week.
These long bond yields are well down on the wild spikes of the March crisis, when the Bank had to intervene to buy bonds to stabilise the market. But they are still well above the projected inflation rate, so in real terms the government is paying a whack to borrow longer term. And the reason for the steepness of the yield curve is that investors are worried about the outlook for SA’s public finances over the long term.
They don’t see the government getting the budget deficit and the debt under control as it claims it will. They believe the government will have to keep coming to the market for more and more money. And if they’re going to willingly lend it all that money they are going to charge for it. The further into the future they have to take on the risk of lending to the government, the more they will charge to take on that risk.
Normally, the shape of the yield curve reflects investors’ perceptions of what inflation will be in future. But in SA’s case it's now a fiscal, supply and demand thing, as it were, rather than an inflation issue as such. It’s playing out in the market in a variety of ways that are increasingly disturbing. The foreign investors SA has relied on heavily over the past decade or so to finance the government’s ever-rising deficit should in theory find it attractive to invest in South African government bonds because of the high yields these offer while global markets are awash with liquidity — as well as the gap between short- and long-term rates making it cheap to hedge their rand exposure.
Yet SA has had modest foreign inflows, with JSE stats showing a R71bn net outflow for the year to date. And as Bank governor Lesetja Kganyago reminded us, as SA no longer has an investment-grade rating, those foreign flows will be more speculative and volatile. At the same time, domestic investors are struggling to absorb all the new issuance the government is putting into the bond market. Last month’s budget indicated it will have to raise an extra R125bn of long-term funding on the domestic market this year, taking into account the cash it will get from the International Monetary Fund and other international institutions as well as its own cash reserves at the Bank, which it plans to draw down. As Kganyago pointed out this week, the government is also taking advantage of those cheap short-term rates by doing more borrowing in the market by way of shorter-term treasury bills.
He and the Bank are under pressure from the proponents of quantitative easing (QE) to do a lot more bond buying to make yields more affordable for the government and even to lend directly to finance the fiscal deficit. And the yield curve is at the heart of the by now well-aired QE debate. But while QE might work for a while, the clear message from the Bank this week was that what the yield curve is telling us is that the government’s high borrowing needs cannot be sustained without deep damage to the economy. If the government can’t fix that, the Bank can’t either.
• Joffe is contributing editor
