Even with a tight rein on planned government spending, a steep decline in tax revenues means public sector borrowing will continue to rise sharply.
Until last year, government had for some time a limited role in capital markets. That's being reversed completely. The budget deficit is budgeted at 6,2% in 2010/2011 (estimated 7,3% in 2009/2010). As the shortfall has to be funded by borrowing, government's net loan debt surges from a low 22,7% of GDP in 2008/2009 to almost 40% by 2012/2013.
This is still not high by international standards - depending on the comparison. In Greece and Italy, public debt last year was 113% of GDP, in Portugal it was 77% and in Ireland 65%.
However, debt issuance, mostly in the domestic capital markets, will surge over the next few years.
Debt servicing costs, at 2,6% of GDP, look low compared with Greece's 12%, but the trend is rising. As a percentage of budgeted revenues (more relevant to spending and growth), servicing costs are budgeted at 11,1% in 2010/2011 and 12,3% next year, up from 9% in 2009/2010. That should be manageable, but represents increased risk for SA.
The quick expansion of government borrowing will affect local capital markets substantially. Demand will have to come mainly from the domestic asset management industry and is difficult to forecast, as investors will consider many factors such as inflation expectations, yields and returns from other asset classes, including equities.
There is a risk that the supply of government bonds will exceed demand and bond yields will have to rise, says Futuregrowth Asset Management portfolio manager Wikus Furstenberg. Higher yields would reflect a downward adjustment in prices because of greater supply and risk. If that happened, it would be negative for investor returns. Yields have already risen significantly since the beginning of last year.
Any signs of higher inflation, which could occur next year, partly because the comparison will then be against this year's lower base, will add to upward pressure on bond yields. This will apply particularly to longer-term bonds - which make up a substantial part of government borrowing - as inflation risks and uncertainty rise in the longer term.
Retirement funds and balanced funds usually hold a portion of their assets in fixed-interest securities, mainly government bonds. They tend to view corporate bonds as a separate asset class, and consider corporate issues on their merits. However, changes in pricing and investor expectations in the capital markets could induce some companies to prefer other ways of raising funds in the next few years, says Furstenberg.
The depth and liquidity of the domestic bond market helps to support significantly higher government borrowing, but the size in absolute terms is a limiting factor. The total listed bond market was valued at about R950bn at the end of January. Central government accounted for just more than half, and state-owned enterprises 16%.
Foreign borrowing by government this year is expected to be R106bn. It rises to R153bn over the next two years, though it remains at about 10,6% of gross government borrowings.
Government's guarantee exposure linked to state-owned enterprises is also rising sharply.
Capital spending programmes by state-owned enterprises, totalling R153bn this year (R108bn of this by Eskom), will be financed internally and by long-term and short-term borrowing in the domestic and foreign markets.
In 2010/2011, two-fifths of the borrowing requirement of these entities and development finance institutions, which total R126bn, will be raised through international funding sources.
