Warning for South African investors
South African asset managers are increasingly exposed to a single risk in local government debt as foreign investors dump the country’s assets.
Foreign investors have steadily reduced their exposure to South African assets as the country’s economic performance deteriorated and its fiscal health worsened.
This culminated in the country being moved into below-investment-grade status by the three major rating agencies.
As South Africa has descended deeper into so-called ‘junk’ status, foreign investors have been consistent sellers of local stocks and bonds for the past decade.
The Reserve Bank noted a modest increase in foreign investor demand for local government bonds since the formation of the Government of National Unity (GNU) in June.
However, the share of government bonds held by foreign investors has not increased as the issuance of state debt has picked up over the past year. In short, supply of government bonds has outstripped demand from foreign investors.
As a result, the domestic financial sector has continued to absorb much of the new bond issuance over the past year, increasing the exposure of local financial institutions to government debt.
Over the past decade, local institutions have picked up the slack left by foreign investors, initially led by South African banks.
The Reserve Bank said South Africa’s structural challenges of low economic growth, high unemployment, and high interest rates have reduced the overall creditworthiness of borrowers and made banks more sensitive to credit risk.
The reduced creditworthiness of borrowers has constrained private sector credit extension, incentivising banks to rather invest in government debt with high yields.
Although this trend seems to have been arrested, banks’ holdings of local government bonds remain well above pre-pandemic levels.
The decline in foreign investors holding local government debt can be seen in the graph below, with local investors picking up the slack.

Since 2018, there has been a significant shift in the type of local financial institutions picking up the slack from foreign investors dumping government bonds.
Asset managers have increasingly invested in government debt due to its attractive yields, doubling their exposure to the asset class since 2015.
The collective exposure of the South African financial system to a single issuer, the government, has contributed to a decline in government bond market liquidity in recent years.
The Reserve Bank said liquidity and depth in domestic bond and equity markets, measured as bond and equity turnover as a percentage of total market capitalisation, have been declining broadly in parallel.
Bid-ask spreads in the government bond market have widened and become more volatile, exacerbating the risk of holding these assets for investors.
The notable spikes in the bid-ask spread have coincided with several unexpected global and domestic events over the past few decades, including the Asian crisis (1997), the Taper Tantrum (2013), South Africa’s downgrade by credit rating agencies (2017) and COVID-19 (2020).
High and volatile spreads are one of the symptoms of low market depth and liquidity.
The Reserve Bank has previously warned local banks and financial institutions about their increased exposure to government debt, which makes them increasingly vulnerable to sovereign risks, instability, and increased borrowing costs.
This increased exposure could potentially crowd out lending to or investing in the private sector, exposing the financial system to market risk in the event of a sharp repricing of government debt.
This also undermines market resilience as the financial system is increasingly exposed to a single common risk.
A higher concentration of government bonds on domestic financial institutions’ balance sheets also inhibits the capacity of the domestic financial system to absorb financial shocks.
It may also lead to increased high volatility and low-liquidity episodes in the domestic bond market, impairing price discovery and deteriorating trading conditions in the rest of the financial market.
In turn, this would reduce the overall resilience of the domestic financial system.

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