Bank, at the South African Bond Market conference organised by the Debt Issuers
Association
5 October 2006
Honoured guests
Ladies and gentlemen
1. Introduction
Thank you for giving me an opportunity to open this conference on the South
African Bond Market. There are several reasons for developing debt markets. The
most fundamental reason is to make financial markets more complete by
generating market interest rates that reflect the opportunity cost of funds at
each maturity. This is essential for efficient investment and financing
decisions. If bond markets do not exist, firms may have to finance the
acquisition of long-term assets by short-term debt, and investment policies may
be biased in favour of short-term projects. Furthermore, debt markets can help
the operation of monetary policy as prices in the long-term bond market give
valuable information about expectations of likely macro-economic developments
and about market reactions to monetary policy moves. In my opening remarks
today I will touch briefly on monetary policy and bond market issues.
2. Monetary policy developments
As you are all no doubt aware, monetary policy does not determine bond
market yields. Nevertheless, monetary policy and the bond markets do impact on
each other in important ways. Expected monetary policy developments are
reflected in bond yields and we, in turn, get a lot of information from the
bond market about market expectations concerning future monetary policy,
inflation and growth. More recently, the development of the inflation-linked
bond market has provided us with further insights into longer-term inflation
expectations in the market.
Not surprisingly, the change in the monetary policy stance in recent months
has been felt in the local bond markets. The repo rate had been unchanged for
14 months, but in June of this year, the Monetary Policy Committee (MPC)
decided to raise the repo rate by 50 basis points, and this was followed by a
further increase of the same amount in August. Although capital market rates
reflect expectations, these expectations are not always correct. At the time of
the first increase, these changes were not fully reflected in bond yields, but
we have seen a significant adjustment since then.
Although our actions took many by surprise, for some time we had been
sounding warnings that we perceived the risks to inflation to be on the upside.
Our warning remains the same today, as we still see significant upside risk to
the inflation outlook.
Our major concern remains the growth of household consumer demand which grew
at an annualised rate of 8% in the second quarter of this year. This
expenditure is still being driven by credit extension growth in excess of 25%,
and household debt as a proportion of disposable income has risen to a
historically high level of 70%. Despite the obvious dangers of such
developments and the recent hikes in interest rates, there are no indications
of any meaningful change in consumer behaviour. It is hard to imagine that such
trends, if unchecked, will not have inflationary consequences.
Another area of concern has been the current account deficit, which although
narrowing from the 6,4% of Gross Development Product (GDP) registered in the
first quarter of 2006, still stood at a high of 6,1% of GDP in the second
quarter. As we have noted in the past, current account deficits are not in
themselves inflationary. There is however a possible risk to the exchange rate
if the deficits are perceived by the markets to be unsustainable, particularly
if the deficits is reflecting higher consumption expenditure. On numerous
occasions we have pointed out the possible implications of the deficit for
investor sentiment and for the rand. The recent exchange rate reaction to the
higher deficit is indicative of this, but it is also part of the adjustment
process. Nevertheless the adjustment in the exchange rate has reached levels
which may pose a further threat to the inflation outlook.
Fortunately it is not all doom and gloom, and there has been at least one
significant improvement in the risk factors affecting the inflation outlook.
International oil prices have offered some respite and come down from their
highs of almost US$80 per barrel in early August, to levels below US$60. We are
aware that this positive development can change at any time, given the delicate
balance between supply and demand in the oil market, and the acute sensitivity
of the oil price to changes in risk perceptions. We are nevertheless fortunate
regarding the timing of this respite.
Domestic economic growth averaged 4,5% and 4,9% in 2004 and 2005
respectively. Despite the change in the monetary policy stance, we do not
anticipate that growth prospects will be significantly undermined. The exchange
rate developments are expected to be positive for export growth, and it will
not be a bad thing if domestic growth is driven by exports and infrastructural
spending, rather than by consumer spending as has been the case in the past two
years. Our focus, however, remains on the inflation target, and we will
continue to strive to maintain Consume Price Index (CPIX) excluding interest on
mortgage bond inflation within the three to six percent target range. The
credibility of our actions will of course be reflected to some extent in the
bond market.
3. Domestic bond market developments
The South African bond market has for some time had an important role in the
financial system, and it is particularly pleasing to note the significant
developments in the corporate bond market. It is also of interest to note the
burgeoning literature on bond market development internationally. A recurring
theme in the literature is the ability of governments or corporates to borrow
from non-residents in their own currency. The inability to borrow in ones own
currency, referred to in the literature as 'original sin,' often leads to
currency mismatch, and ultimately to balance sheet vulnerability in the event
of significant exchange rate changes. South Africa stands out as one of the few
emerging market economies that do not suffer from 'original sin,' given the
long history of resident and non-resident participation in the domestic bond
market. The development of the corporate bond market adds a further important
dimension to the market.
It is common knowledge that the South African bond market is highly
developed and very deep. There are continuous innovations as is witnessed by
the listed products offered by both the Bond Exchange of South Africa and the
Yield-X of the Johannesburg Securities Exchange (JSE). Whereas in its infant
stages the Bond Exchange was dominated by government and parastatals, in the
recent past corporate issuances have been increasing. Since the South African
bond market has historically been a predominantly government and
government-related debt market, the use of credit ratings has been limited.
With the introduction of corporate bonds in recent years, this has changed as a
need has emerged for a better understanding of credit risk.
The corporate bond market is today the fastest-growing segment of the bond
market, as new issuances of corporate bonds have overtaken those of government
bonds. Government has also been borrowing less because of fiscal discipline and
more efficient tax collection by the South African Revenue Services.
Securitisation issuances have also picked up considerably, and while the banks
are major issuers in this market, there are other active players as well. The
number of issuers accessing the debt capital markets has grown from a single
issuer in the period prior to 2000, to 14 issuers in 2005.
The secondary market for bonds in general is developing very slowly.
Contributing to this state of affairs is that buyers tend to buy and hold due
to the attractiveness of these instruments in their portfolios. However, there
are early signs of a more active secondary market beginning to resurface as
turnover has increased in the past year.
4. Conclusion
The stable inflation environment means that the fixed income structure of
bonds has become relatively more attractive to investors with risk profiles
that demand a steady real rate of return. Also, economic growth has been more
robust in recent years amid heightened investor optimism about the country's
future prospects. Improved economic fundamentals translate into enhanced growth
prospects for South African corporates, and a concomitant need for long-term
debt financing. The development of this sector of the bond market offers
borrowers in the private sector access to long-term finance from the capital
markets.
I am aware that some of South Africa's important corporates are here to
participate in this conference. We look forward with keen interest to your
contributions to the growth of this sector of the market. I wish you well
during your deliberations.
Thank you for your attention.
Issued by: South African Reserve Bank
5 October 2006
Source: South African Reserve Bank (http://www.reservebank.co.za)
