South African bond yields hit record lows this week as foreigners piled into emerging market debt but they are looking vulnerable to a sudden reversal amid fears ratings agencies may downgrade the continent's biggest sovereign.
The trigger for the market turning looks likely to come from policy uncertainty caused by behind-the-scenes political posturing ahead of an internal election in the ruling ANC in December, analysts said.
Mining policy - the subject of much debate after a major ANC conference last week - is under particular scrutiny, and local dealers say they are preparing for a stampede for the exit by the 50 billion rand, $6.2 billion, of foreign cash that has sloshed into the bond market so far this year.
“The door won't be big enough,” one Johannesburg-based dealer said.
Although growth in the mining sector has not kept pace with the rest of the economy since the end of apartheid in 1994, it still accounts for 8 percent of output, and the government has identified it as vital to creating jobs.
“The lack of clarity with regards to future policies in key economic areas - and the mining sector is a key area of South African economy - at the moment is certainly something that weighs negatively on the rating,” said Konrad Reuss, Sub-Saharan Africa managing director of Standard & Poor's.
Despite such concerns, yield-chasing foreign cash has continued to come into South Africa, with inflows so far this year up 60 percent on the same period in 2011.
The 2015 and 2021 bonds, the most popular debt last month, hit fresh record highs in the last two days, pushing yields to 5.91 and 7.07 percent respectively, and look set to go lower as expectations of interest rate cuts rise.
Foreigners bought over 20 billion rand of South African paper in June - the second-biggest monthly inflow on record - and may be driven to increase their holdings on the expectation of lower rates, even though that implies lower yields.
“More monetary accommodation may actually encourage foreign bond investors due to the implied capital appreciation of their existing bond holdings,” Absa Capital said in a note this week.
Prices are also being supported by the belief that several billion dollars in bond portfolio flows relating to South Africa's inclusion from October in Citigroup's influential World Government Bond Index are yet to arrive.
Such opinions sit uncomfortably with the view of many analysts that domestic politics are entering a turbulent six months ahead of the ANC leadership vote in the central city of Mangaung.
Although incumbent President Jacob Zuma is the firm favourite to win re-election, research Group Eurasia said populism ahead of the vote posed a major risk to growth.
“The year is likely to inflict lasting damage on policy-making and institutions, and it's almost certainly a lost year,” the group said in its 2012 outlook.
With the three big ratings agencies all having South Africa on negative outlook, and with Europe, its biggest trading partner, in the doldrums, a credit downgrade is not off the cards.
“Political uncertainty will continue until the ANC's leadership conference at the end of the year,” Fitch said in a note.
“This backdrop is not conducive to the tough structural policy choices, particularly in the labour market and education area, needed to address South Africa's critical problems of unemployment and skills shortage.” -Reuters