Nene fired: what few are talking about


With the sudden ‘redeployment’ of (now former) Finance Minister Nhlanhla Nene, South Africans were up in arms. While many expressed shock and disappointment (in both our president and our foreign exchange rates), it is fair to say that such responses would have required some unwarranted positive expectations to begin with.

For much of yesterday, social media exploded with comments and memes about our currency. Such figures as Rob Davies, our communist Minister of Trade and Industry, will undoubtedly relish the weakening of the Rand. But as prices adjust to adapt to new market characteristics, and the often-touted surge in manufacturing and exports fails to materialise, ordinary South Africans will feel the effects.

While the value of the Rand has declined around 18% since June of this year, the real casualty is the South African bond market. Nene’s removal, and his replacement, bring great uncertainty regarding South Africa’s fiscal and economic future. Owners of South African government debt – of which foreigners are the largest group – engaged in a massive sell-off yesterday and have sent a very clear message through the markets: South Africa is too risky for investment.

In order to better understand the events of the day and for those not familiar with the purpose and inner workings of the bond market, it is worthwhile briefly going over some first principles.

When the government needs to borrow money to fund its expenditure, it issues bonds: investors loan a given amount of money to the government, and the government promises to pay the lender interest in addition to paying back the initial (principal) amount. Once investors – usually pension funds and other large financial institutions – have bought their ‘IOUs’ (bonds) from the government, they are able to trade these with other investors. This is known as the ‘secondary’ market.

One of the main characteristics of bonds is that their yields – the returns investors earn for buying and holding bonds – behave strictly inversely to their market price. In other words, when a bond’s price falls, its yield necessarily rises, and vice versa.

With yesterday’s flight out of South African bonds, prices fell and yields shot up drastically. Pictured below is the yield over time for the South African 10-year bond. In this morning’s trade, the sell-off has continued and yields keep testing higher levels. It is interesting to note that even after the downgrade by credit ratings agencies on 4 December, the yield increase was quite mild compared to the spike that occurred yesterday.

Yield on the SA 10-year bond over the last few months
Yield on the SA 10-year bond over the last few months.

But it was not just the 10-year bond that took a beating during the day: the entire spectrum of South African bonds (barring 3-month Treasury bills) experienced similar sudden and large increases in yields. Some yields increased by over 1%; on a single day, that is massive. South African bond yields have not seen these levels since 2008, when overseas investors panicked about the recession and decided to liquidate their emerging-market assets.

No, these are not different curves for different countries. This is how SA’s yield curve shifted in one day.
No, these are not different curves for different countries – this is how SA’s yield curve shifted in one day.

All of this prompts an important question: where to from here? If the drop in investor confidence persists – which seems quite likely at this point – the government is going to be paying more to borrow money in order to finance its budget deficits. This in turn means that more of the national budget will go towards debt payments, and less towards actual ‘services’. In order to maintain planned levels of expenditure, the government will either have to borrow more, or raise the taxes on our already-minute tax base.

There is another important implication to take away from these antics. The firing of Nene simply means that our government will transition from managed to directionless chaos. As South Africa – or rather, the select few who get to make decisions of great importance for the rest of us – continues on the current trajectory, economic conditions will undoubtedly decline. The real effects of numbers jumping around wildly in the foreign exchange, equity and bond markets will not be fully tangible for some time.

By the time these effects do set in, many would have forgotten the chain of events that set all of this in motion. There is little reason to believe that the public and the government will place the blame squarely where it belongs. Instead, we will probably hear about how awful ‘capitalism’ is and how it causes all of our problems, even though free markets are already strongly opposed and hampered by rhetoric and government policy. The big irony, of course, is that as the government’s actions weaken the economy, it will insist on taking more control over economic matters in the name of ‘public interest’.

If nothing else, at least one thing can be taken away from yesterday: since neither Parliament, the ruling party, nor South African citizens have voted against our president, the government’s creditors have cast a vote of no confidence in a most spectacular fashion.