Date: 25/10/2005
Source: South African Reserve Bank
Title: Mboweni: Bond Market Spire Awards
Remarks by Governor TT Mboweni at the Bond Market Spire Awards, Hyatt Hotel, Rosebank, Johannesburg
1. Introduction
Ladies and Gentlemen, I thank you for the invitation to be present at this illustrious occasion, congratulating and celebrating the successes achieved by such talented individuals as yourselves. The Spire Awards have over the last four years become the benchmark for superior performance by dealers in the domestic bond market and the institutions which they represent.
Allow me to express my personal congratulations to all of you who have been nominated for various award categories, especially the winners of these coveted awards. One is reminded at occasions like these, how sophisticated and mature the domestic bond market has become since the days (barely eight years ago) when the South African Reserve Bank still used to be the sole market-maker in government bonds in South Africa. Somehow, it is a pity that we did not have the Spire Awards in those years, because the Reserve Bank would have been the winner in all categories!
Having said this facetiously of course, I am nevertheless thankful for the role which the Reserve Bank has played in the development of the market for government bonds. For example, in 1990 the Bank started to quote firm two-way prices in certain benchmark government bonds and traded in minimum amounts of R1 million with a spread of two basis points between the buying and selling yield. The minimum amount was later increased to R5 million and in 1995 the minimum amount was fixed at R10 million, with the spread usually kept at three basis points.
The Reserve Bank’s transactions in government bonds increased substantially in those years in accordance with its objective of establishing an active secondary market in government bonds. This market has witnessed significant changes over the last eight years. For example, trading on the gilts floor of the Johannesburg Stock Exchange came to an end in November 1995. Bond trading after that date shifted to the Bond Market Association (BMA), which operated an informal screen and telephone trading system with the Universal Exchange Corporation Ltd (Unexcor) as its clearing house.
The Rulebook and underlying principles of the official bond market were approved in March 1996 and the Bond Exchange of South Africa (BESA) was licensed to trade on 15 May 1996. BESA introduced various operational and regulatory changes over the years to enhance competitiveness and compliance with international standards. One of the major improvements was the shortening of the settlement period. It is now hard to believe that bond trades settled on the so-called second-Thursday principle (i.e. up to 14 days after the trading day) until 17 November 1997 when the T + 3 settlement principle was introduced, thereby significantly lowering the settlement risk associated with bond trading. I am also aware that there are presently efforts underway to reduce this settlement period even further.
Whereas the Reserve Bank used to be a very active player in the bond market in years gone by, it has subsequently assumed a much more passive role in the daily trading and marketing of government bonds. However, it is still very much involved and aware of the most recent developments through its representation and participation in various committees and other platforms such as the Debt Issuers Association; the Bond Advisory Committee; the Stakeholder Forum of the Bond Exchange; the South African Institute of Financial Markets; and the Primary Dealers Committee.
In addition to these endeavours, the Reserve Bank administers the weekly government bond auctions on behalf of the National Treasury and conducts a joint surveillance function of the Primary Dealer Banks. It was not without a sigh of relief that the Bank’s market-making role came to an end in 1998 when the National Treasury transferred this function to a panel of primary dealer banks, freeing the Bank to concentrate on its core business, namely the implementation of monetary policy which is the topic that I understand best. So, please allow me to briefly look at recent market developments in the world and in South Africa and to conclude my address with a few remarks on monetary policy issues.
2. Recent Market Developments
There have certainly been a multitude of interesting developments in both the global and domestic financial markets since the Bank handed over its market-making role in 1998, ranging from the emerging market crisis of that year to the significant depreciation of the rand in 2001 and the US/Iraq war. Since then, however, markets have recovered remarkably well.
Domestic bond yields declined from just over 20 per cent in mid-1998 and have been on a general decline since. The yield on the R153 bond posted a low of just under 7,70 per cent in February this year. Excess global liquidity, falling bond yields internationally, combined with a significant reduction in the repo rate, credit ratings upgrades, government’s debt consolidation process, and non-resident interest in the domestic markets have all resulted in this significant decline in debt servicing costs. In fact, long-term interest rates are at levels last witnessed 25 years ago. Allow me to pause for a moment or two on these issues.
The issue surrounding excess global liquidity is well-known. All of us here tonight are well aware that the accommodative monetary policy stance of the Federal Reserve of recent years has contributed to reduced risk aversion and therefore rendered emerging markets attractive. The Federal Reserve’s gradual removal of this accommodative policy has been done in a responsible and predictable manner which has not destabilised financial markets. While upward pressure on local yields may be exerted by the Fed moving from an accommodative to neutral/tightening policy, it is unlikely that this will result in any shocks in the domestic bond market.
The significant reduction in the repo rate can be ascribed to the introduction of inflation targeting in 2001, the containment of inflation expectations, and the positive influence which the rand exchange rate has had on inflation. Going hand in hand with this is the elimination of the net open forward position from negative USD23 billion in 1998, to a position today where we can boast a net reserves position of over USD16 billion. Partly as a result of this, the rand has appreciated from its 2001 low levels, making a major contribution to CPIX remaining within the 3 – 6 per cent target band for the past 24 consecutive months. The rand, whilst still volatile, is considerably less so than a few years ago.
In line with this, the improvement in South Africa’s long-term foreign currency debt rating from BB (high risk, speculative grade credit) in 1994 to BBB in 2005 (investment grade rating), made South Africa’s debt much more attractive to the international community. The most recent upgrades by Fitch and Standard and Poor’s represent a significant cost saving for the Bank in terms of its syndicated loans, and the concomitant decline in margins also serves as an important benchmark for other South African borrowers wishing to tap the international market. The upgrades have also allowed South African debt to trade at tighter spreads than the Emerging Market Bond Index (EMBI), indicating that investors share the confidence expressed by international rating agencies and regard South Africa in a positive light in comparison to its competitors.
The introduction of the Global Bond Index Emerging Markets (GBI-EM+) by JP Morgan, which tracks changes in emerging-market local-currency bond prices, should be particularly helpful to South Africa, given that most of the country’s debt is denominated in local currency, unlike the case in most other emerging markets. In addition, it also implies more dedicated bond inflows into our market, possibly of a more lasting nature. In this light, non-residents have been particularly active in the domestic bond and equity markets this year. Non-resident participation in trading on the Bond Exchange, measured as the sum of their purchases and sales as a percentage of total purchases and sales of bonds, increased markedly from 9 per cent in February 2004 to as high as 17,5 per cent in February 2005. Incidentally, non-resident participation in share trading on the Johannesburg Stock Exchange (JSE) currently averages approximately 20 per cent. Non-residents’ interest in South African securities also frequently shifts from one market to another: In the third quarter of this year, for instance, they were net purchasers of R14 billion in shares but net sellers of R11 billion in bonds.
Talking of large numbers, overall bond market liquidity has certainly gone from strength to strength. Turnover on the Bond Exchange rose from R2 006 billion in 1995 to R9 504 billion in 2004, in other words, last year two months’ turnover on the bond market was more than the entire year’s gross domestic product.
Another area of the bond market, which perhaps does not receive as much attention, but remains on the radar screens of the South African Reserve Bank, is that of the Eurorand bond market. This market has witnessed a flurry of activity this year, with a total issuance size for 2005 of over R9 billion, the highest issuance since 1999. The demand for rand-denominated bonds issued by highly rated non-resident institutions contributes positively to the value of both the rand and domestic bonds.
The government debt consolidation process has also allowed the cost of borrowing to decline markedly. Even though debt issuance has increased since 2003/04, sound debt management has been such that new issuance is spread across the maturity spectrum of the yield curve. The latter normalised somewhat in recent months owing to, amongst others, the fact that the National Treasury increased supply at the longer end of the curve.
With the cost of borrowing falling as dramatically as it has, the bond market has become a more appealing corporate finance tool and, as such, corporate listings have become more popular. Since the very first listing of a corporate bond (South African Breweries) in 1994, the corporate bond market has increased considerably in size: More recently it expanded from just under R40 billion in 2002 to over R120 billion today, an increase of over 200 per cent!
The innovation in this sector is also something to be proud of, from issuance of vanilla bonds to securitisations and commercial paper. Not only do these innovations offer debt at lower interest rates than vanilla bonds, but also provides lower income groups with access to home mortgage finance. We have also witnessed the first listing of a non-resident bank on the Bond Exchange, again displaying the confidence in South Africa. The introduction of inflation-linked government bonds in 2000 was a further significant innovation and is quite helpful in providing monetary policymakers and analysts with important information on inflation expectations through readings of the so-called breakeven inflation rate.
Whilst much has been achieved, there are still many opportunities and challenges ahead. Non-government bond issuance has increased sharply; however, banks continue to account for the bulk of this issuance. In addition, the buy-and-hold approach to corporate bonds and inflation-linked bonds, in particular, renders these segments of the bond market relatively illiquid. The municipal bond market is still in a developing stage but can certainly contribute to enhancing the breadth and depth of the domestic bond market. Finally, the significant amount of infrastructure spending planned for the next few years is likely to boost the supply of corporate bonds and therefore increase liquidity in this market.
3. Monetary Policy
For the past two years Consumer Price Index (CPIX) inflation remained within the target range of 3 to 6 per cent. Production prices were influenced more directly by the strength of the exchange value of the rand, bringing inflation in South Africa in 2004 to a level that was slightly below the world average rate of inflation. In August 2004 and again in April 2005, the Monetary Policy Committee (MPC) reduced the repurchase rate by 50 basis points, essentially motivated by indications that prospects for future inflation had improved. In line with this, the variability of short-term and long-term interest rates and the volatility of the effective exchange rate of the rand receded appreciably, reinforcing the platform for launching faster growth and development in the coming years.
International crude oil prices recently moved to record-high levels of around US$70 per barrel, casting fears in the marketplace about future inflationary pressures. As noted before, the immediate or first-round effects of rising energy prices would have to be accepted; however, monetary policy will not allow this to develop into an inflationary spiral. The Reserve Bank will continue to honour its mandate as enshrined in the Constitution and give explicit content to the CPIX inflation rate target range set by Government. The Bank’s inflation forecasting model shows that CPIX inflation is expected to remain within the target range reaching an upper turning point of just below 6 per cent in the first two quarters of 2006 and resuming a moderate downward trajectory thereafter. As noted in the MPC statement, the Bank will continue to monitor the inflation outlook and will not hesitate to respond to any signs of second-round inflationary pressures.
The role of the exchange rate also merits some consideration. Perhaps, firstly, to reiterate and again emphasise that the Reserve Bank has been given a target for the inflation rate and not, as some have speculated, for the exchange rate. The exchange rate is determined by supply and demand in the foreign exchange market, and not by the Bank. In recent years, the emphasis has been on accumulating international reserves, which may have had some exchange rate consequences, but did not signify the adoption of a target level for the exchange rate. When abundant amounts of foreign exchange are available in the market (and the rand is comparatively strong) it presents the Bank with a good opportunity to buy more foreign exchange from the market. This is how the Bank managed to increase the value of the official gross reserves to nearly $20 billion by the end of September 2005.
Of course, the Bank cannot disregard the exchange rate, as this is one of the variables that can have quite a pronounced effect on inflation. That is why we would prefer a relatively stable exchange rate for the rand. Too much volatility creates adjustment costs, which can prove to be quite painful and render entire sectors uneconomical and others extremely viable within a very short period of time. The nominal effective exchange rate of the rand depreciated by approximately 6 per cent since the beginning of the year and has been relatively stable over the period. The volatility that did occur was to a large extent a reflection of movements of the exchange rate between the euro and the US dollar. The preference for a stable and competitive level of the exchange rate reflects the need for sustainability, for exporters to move into foreign markets and to stay there.
4. Conclusion
Clearly, the markets have been through some testing times, but we certainly have a come long way from the days of double digit inflation, and the rand being a one-way bet. There may be many more trying times ahead, however, I am certain that we have built ourselves a solid foundation which will stand us in good stead. In conclusion, let me once again congratulate all of you who have been nominated for awards this evening, an achievement to be proud of indeed!
Issued by: South African Reserve Bank
25 October 2005
Source: South African Reserve Bank
Title: Mboweni: Bond Market Spire Awards
Remarks by Governor TT Mboweni at the Bond Market Spire Awards, Hyatt Hotel, Rosebank, Johannesburg
1. Introduction
Ladies and Gentlemen, I thank you for the invitation to be present at this illustrious occasion, congratulating and celebrating the successes achieved by such talented individuals as yourselves. The Spire Awards have over the last four years become the benchmark for superior performance by dealers in the domestic bond market and the institutions which they represent.
Allow me to express my personal congratulations to all of you who have been nominated for various award categories, especially the winners of these coveted awards. One is reminded at occasions like these, how sophisticated and mature the domestic bond market has become since the days (barely eight years ago) when the South African Reserve Bank still used to be the sole market-maker in government bonds in South Africa. Somehow, it is a pity that we did not have the Spire Awards in those years, because the Reserve Bank would have been the winner in all categories!
Having said this facetiously of course, I am nevertheless thankful for the role which the Reserve Bank has played in the development of the market for government bonds. For example, in 1990 the Bank started to quote firm two-way prices in certain benchmark government bonds and traded in minimum amounts of R1 million with a spread of two basis points between the buying and selling yield. The minimum amount was later increased to R5 million and in 1995 the minimum amount was fixed at R10 million, with the spread usually kept at three basis points.
The Reserve Bank’s transactions in government bonds increased substantially in those years in accordance with its objective of establishing an active secondary market in government bonds. This market has witnessed significant changes over the last eight years. For example, trading on the gilts floor of the Johannesburg Stock Exchange came to an end in November 1995. Bond trading after that date shifted to the Bond Market Association (BMA), which operated an informal screen and telephone trading system with the Universal Exchange Corporation Ltd (Unexcor) as its clearing house.
The Rulebook and underlying principles of the official bond market were approved in March 1996 and the Bond Exchange of South Africa (BESA) was licensed to trade on 15 May 1996. BESA introduced various operational and regulatory changes over the years to enhance competitiveness and compliance with international standards. One of the major improvements was the shortening of the settlement period. It is now hard to believe that bond trades settled on the so-called second-Thursday principle (i.e. up to 14 days after the trading day) until 17 November 1997 when the T + 3 settlement principle was introduced, thereby significantly lowering the settlement risk associated with bond trading. I am also aware that there are presently efforts underway to reduce this settlement period even further.
Whereas the Reserve Bank used to be a very active player in the bond market in years gone by, it has subsequently assumed a much more passive role in the daily trading and marketing of government bonds. However, it is still very much involved and aware of the most recent developments through its representation and participation in various committees and other platforms such as the Debt Issuers Association; the Bond Advisory Committee; the Stakeholder Forum of the Bond Exchange; the South African Institute of Financial Markets; and the Primary Dealers Committee.
In addition to these endeavours, the Reserve Bank administers the weekly government bond auctions on behalf of the National Treasury and conducts a joint surveillance function of the Primary Dealer Banks. It was not without a sigh of relief that the Bank’s market-making role came to an end in 1998 when the National Treasury transferred this function to a panel of primary dealer banks, freeing the Bank to concentrate on its core business, namely the implementation of monetary policy which is the topic that I understand best. So, please allow me to briefly look at recent market developments in the world and in South Africa and to conclude my address with a few remarks on monetary policy issues.
2. Recent Market Developments
There have certainly been a multitude of interesting developments in both the global and domestic financial markets since the Bank handed over its market-making role in 1998, ranging from the emerging market crisis of that year to the significant depreciation of the rand in 2001 and the US/Iraq war. Since then, however, markets have recovered remarkably well.
Domestic bond yields declined from just over 20 per cent in mid-1998 and have been on a general decline since. The yield on the R153 bond posted a low of just under 7,70 per cent in February this year. Excess global liquidity, falling bond yields internationally, combined with a significant reduction in the repo rate, credit ratings upgrades, government’s debt consolidation process, and non-resident interest in the domestic markets have all resulted in this significant decline in debt servicing costs. In fact, long-term interest rates are at levels last witnessed 25 years ago. Allow me to pause for a moment or two on these issues.
The issue surrounding excess global liquidity is well-known. All of us here tonight are well aware that the accommodative monetary policy stance of the Federal Reserve of recent years has contributed to reduced risk aversion and therefore rendered emerging markets attractive. The Federal Reserve’s gradual removal of this accommodative policy has been done in a responsible and predictable manner which has not destabilised financial markets. While upward pressure on local yields may be exerted by the Fed moving from an accommodative to neutral/tightening policy, it is unlikely that this will result in any shocks in the domestic bond market.
The significant reduction in the repo rate can be ascribed to the introduction of inflation targeting in 2001, the containment of inflation expectations, and the positive influence which the rand exchange rate has had on inflation. Going hand in hand with this is the elimination of the net open forward position from negative USD23 billion in 1998, to a position today where we can boast a net reserves position of over USD16 billion. Partly as a result of this, the rand has appreciated from its 2001 low levels, making a major contribution to CPIX remaining within the 3 – 6 per cent target band for the past 24 consecutive months. The rand, whilst still volatile, is considerably less so than a few years ago.
In line with this, the improvement in South Africa’s long-term foreign currency debt rating from BB (high risk, speculative grade credit) in 1994 to BBB in 2005 (investment grade rating), made South Africa’s debt much more attractive to the international community. The most recent upgrades by Fitch and Standard and Poor’s represent a significant cost saving for the Bank in terms of its syndicated loans, and the concomitant decline in margins also serves as an important benchmark for other South African borrowers wishing to tap the international market. The upgrades have also allowed South African debt to trade at tighter spreads than the Emerging Market Bond Index (EMBI), indicating that investors share the confidence expressed by international rating agencies and regard South Africa in a positive light in comparison to its competitors.
The introduction of the Global Bond Index Emerging Markets (GBI-EM+) by JP Morgan, which tracks changes in emerging-market local-currency bond prices, should be particularly helpful to South Africa, given that most of the country’s debt is denominated in local currency, unlike the case in most other emerging markets. In addition, it also implies more dedicated bond inflows into our market, possibly of a more lasting nature. In this light, non-residents have been particularly active in the domestic bond and equity markets this year. Non-resident participation in trading on the Bond Exchange, measured as the sum of their purchases and sales as a percentage of total purchases and sales of bonds, increased markedly from 9 per cent in February 2004 to as high as 17,5 per cent in February 2005. Incidentally, non-resident participation in share trading on the Johannesburg Stock Exchange (JSE) currently averages approximately 20 per cent. Non-residents’ interest in South African securities also frequently shifts from one market to another: In the third quarter of this year, for instance, they were net purchasers of R14 billion in shares but net sellers of R11 billion in bonds.
Talking of large numbers, overall bond market liquidity has certainly gone from strength to strength. Turnover on the Bond Exchange rose from R2 006 billion in 1995 to R9 504 billion in 2004, in other words, last year two months’ turnover on the bond market was more than the entire year’s gross domestic product.
Another area of the bond market, which perhaps does not receive as much attention, but remains on the radar screens of the South African Reserve Bank, is that of the Eurorand bond market. This market has witnessed a flurry of activity this year, with a total issuance size for 2005 of over R9 billion, the highest issuance since 1999. The demand for rand-denominated bonds issued by highly rated non-resident institutions contributes positively to the value of both the rand and domestic bonds.
The government debt consolidation process has also allowed the cost of borrowing to decline markedly. Even though debt issuance has increased since 2003/04, sound debt management has been such that new issuance is spread across the maturity spectrum of the yield curve. The latter normalised somewhat in recent months owing to, amongst others, the fact that the National Treasury increased supply at the longer end of the curve.
With the cost of borrowing falling as dramatically as it has, the bond market has become a more appealing corporate finance tool and, as such, corporate listings have become more popular. Since the very first listing of a corporate bond (South African Breweries) in 1994, the corporate bond market has increased considerably in size: More recently it expanded from just under R40 billion in 2002 to over R120 billion today, an increase of over 200 per cent!
The innovation in this sector is also something to be proud of, from issuance of vanilla bonds to securitisations and commercial paper. Not only do these innovations offer debt at lower interest rates than vanilla bonds, but also provides lower income groups with access to home mortgage finance. We have also witnessed the first listing of a non-resident bank on the Bond Exchange, again displaying the confidence in South Africa. The introduction of inflation-linked government bonds in 2000 was a further significant innovation and is quite helpful in providing monetary policymakers and analysts with important information on inflation expectations through readings of the so-called breakeven inflation rate.
Whilst much has been achieved, there are still many opportunities and challenges ahead. Non-government bond issuance has increased sharply; however, banks continue to account for the bulk of this issuance. In addition, the buy-and-hold approach to corporate bonds and inflation-linked bonds, in particular, renders these segments of the bond market relatively illiquid. The municipal bond market is still in a developing stage but can certainly contribute to enhancing the breadth and depth of the domestic bond market. Finally, the significant amount of infrastructure spending planned for the next few years is likely to boost the supply of corporate bonds and therefore increase liquidity in this market.
3. Monetary Policy
For the past two years Consumer Price Index (CPIX) inflation remained within the target range of 3 to 6 per cent. Production prices were influenced more directly by the strength of the exchange value of the rand, bringing inflation in South Africa in 2004 to a level that was slightly below the world average rate of inflation. In August 2004 and again in April 2005, the Monetary Policy Committee (MPC) reduced the repurchase rate by 50 basis points, essentially motivated by indications that prospects for future inflation had improved. In line with this, the variability of short-term and long-term interest rates and the volatility of the effective exchange rate of the rand receded appreciably, reinforcing the platform for launching faster growth and development in the coming years.
International crude oil prices recently moved to record-high levels of around US$70 per barrel, casting fears in the marketplace about future inflationary pressures. As noted before, the immediate or first-round effects of rising energy prices would have to be accepted; however, monetary policy will not allow this to develop into an inflationary spiral. The Reserve Bank will continue to honour its mandate as enshrined in the Constitution and give explicit content to the CPIX inflation rate target range set by Government. The Bank’s inflation forecasting model shows that CPIX inflation is expected to remain within the target range reaching an upper turning point of just below 6 per cent in the first two quarters of 2006 and resuming a moderate downward trajectory thereafter. As noted in the MPC statement, the Bank will continue to monitor the inflation outlook and will not hesitate to respond to any signs of second-round inflationary pressures.
The role of the exchange rate also merits some consideration. Perhaps, firstly, to reiterate and again emphasise that the Reserve Bank has been given a target for the inflation rate and not, as some have speculated, for the exchange rate. The exchange rate is determined by supply and demand in the foreign exchange market, and not by the Bank. In recent years, the emphasis has been on accumulating international reserves, which may have had some exchange rate consequences, but did not signify the adoption of a target level for the exchange rate. When abundant amounts of foreign exchange are available in the market (and the rand is comparatively strong) it presents the Bank with a good opportunity to buy more foreign exchange from the market. This is how the Bank managed to increase the value of the official gross reserves to nearly $20 billion by the end of September 2005.
Of course, the Bank cannot disregard the exchange rate, as this is one of the variables that can have quite a pronounced effect on inflation. That is why we would prefer a relatively stable exchange rate for the rand. Too much volatility creates adjustment costs, which can prove to be quite painful and render entire sectors uneconomical and others extremely viable within a very short period of time. The nominal effective exchange rate of the rand depreciated by approximately 6 per cent since the beginning of the year and has been relatively stable over the period. The volatility that did occur was to a large extent a reflection of movements of the exchange rate between the euro and the US dollar. The preference for a stable and competitive level of the exchange rate reflects the need for sustainability, for exporters to move into foreign markets and to stay there.
4. Conclusion
Clearly, the markets have been through some testing times, but we certainly have a come long way from the days of double digit inflation, and the rand being a one-way bet. There may be many more trying times ahead, however, I am certain that we have built ourselves a solid foundation which will stand us in good stead. In conclusion, let me once again congratulate all of you who have been nominated for awards this evening, an achievement to be proud of indeed!
Issued by: South African Reserve Bank
25 October 2005
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