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The Budget cost of playing Russian roulette
Uncertainty within South Africa’s political economy has increased further this week as the now widely publicised deterioration of the relationship between South Africa and the US has gathered momentum. While the rand has reached our target of R19,00 against the USD, bond yields have moved well beyond what we expected. At this point, bond yields reflect substantial fiscal risk, in our view.
Worsening political economy; exports to the US (and growth) at risk
South Africa risks falling out of the AGOA trade agreement with the US, which would threaten around USD3,4bn worth of exports. Our initial estimates suggest that South Africa’s GDP growth could decline by almost 1% during the first year of exclusion from the AGOA.
The Budget implication of three scenarios
We estimate the impact of lower growth amid rising political tension with the US on South Africa’s fiscal position and the resultant impact on bond yields. We present three broad scenarios – our current base case, exclusion from the AGOA and a scenario where more punitive measures are taken against the country.
Reaction of bond yields to each scenario
We simulate our fair-value estimate for the 10-year bond yield in each scenario. Exclusion from the AGOA could see South Africa’s bond yield rise by around 60 basis points (bps) higher than where it would have been under a fiscal outcome projected by the Budget. What is also clear is that at current levels, the 10-year bond yield is pricing in plenty of country risk already.
Keep an eye on debt levels and debt-servicing costs
Based on the National Treasury’s (NT’s) own modelling analysis from the Budget and using the market pricing currently (inflation 100 bps higher, yields 100 bps higher and a rand that is R2/USD weaker), the debt level would need to rise by R84,4bn, while debt-servicing costs should increase by R6,5bn.