Business Maverick

BUSINESS MAVERICK Op-Ed

Right now, local credit markets are not as deep and liquid as Ramaphosa says

Right now, local credit markets are not as deep and liquid as Ramaphosa says
When the oil price crisis appeared, it resulted in two black swan events colliding and putting the financial markets under unprecedented pressure. (Image: Adobestock)

Last night President Cyril Ramaphosa assured South Africans that our financial markets are deep and liquid. But that is not the case. Asset managers are saying the credit market is seizing up and that bolder action from the SA Reserve Bank — not merely a verbal commitment — is urgently needed to restore the market to efficient functioning.

South African credit markets are experiencing an acute liquidity crunch and the central bank will need to be bolder than it has been if it wants to restore equilibrium to a financial market that greases the wheels of the economy.

In his speech last night, President Cyril Ramaphosa assured us that South Africa has a strong financial market with deep and liquid markets. He said the SA Reserve Bank (SARB) was ready to do what it takes to make sure the financial sector operates well “during this very difficult time”, a statement that mirrors similarly firm commitments made by the main developed market central banks over the past few weeks.

However, he didn’t detail any further actions that might be forthcoming from the Bank when, in reality, the SARB is falling further and further behind global central banks in adopting the strong measures needed to restore the domestic credit market to health.

Credit markets fund the debt obligations of banks, corporates and the government and when liquidity dries up, as it last did during the 2008 financial crisis, the monetary authorities have little choice other than to step in and prop the markets up. Without their support, there would be a wholesale sell-off in the market, as witnessed 12 years ago during the crisis, exacerbating a panicked flight to safety that results in plummeting prices and inflicts significant losses on investors. 

Globally, the financial markets have been contending with unsustainable demand for dollar funding. The burgeoning demand is being driven by investors who are seeking to fund larger-than-expected margin calls because stock markets have sold off so sharply, corporates requiring funding urgently and panicked investors rushing for the safety of cash, according to Prescient Fixed Income portfolio manager Henk Kotze.

Less than a month ago, commentators were pointing out that this was not like the financial market crisis because it was a health-related, not a credit, event. But when the oil price crisis appeared, it resulted in two black swan events colliding and putting the financial markets under unprecedented pressure.

Developed market central banks have responded aggressively to the liquidity strains in their financial markets by taking significant steps to steady the market and make dollar funding more readily available to corporates and investors. In the latest move, yesterday the US Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of England, the Bank of Canada and the Swiss National Bank banded together to boost dollar liquidity in a second emergency move to address the overwhelming demand for dollar-based funding.

In its statement accompanying the announcement, the Fed says it is “committed to using its full range of tools to support households, businesses, and the US economy overall in this challenging time.” It adds that it intends to take aggressive action to limit job and income losses and to promote a swift economic recovery.

This contrasts with the more tempered tone adopted by the SARB last week and the relatively limited action taken on Thursday last week. The size of the repo rate cut did exceed market expectations but, in its official statement, the Bank failed to address the extent of the liquidity issues currently plaguing the local credit market.

Then, unusually, the Bank went on to announce measures aimed at introducing additional liquidity into the markets the following morning. These included a percentage point rate reduction in the Bank’s standing debt facilities and shifting to daily rather than weekly seven-day repurchase financing (repo) auctions. These initiatives increase the banks’ access to funding from the Reserve Bank as the lender of last resort.

However, these conditions in the fixed income market haven’t improved since then, and, says Kotze, capital markets are still not functioning as they should. Liquidity constraints had been mounting over the last couple of weeks and he doesn’t believe the SARB went far enough last week, saying it should have used all the weapons in its arsenal to improve trading conditions.

In a clear sign of the pressure the market is under, bond market bid-offer spreads are unusually wide and price discovery has become exceedingly difficult. Kotze notes that bid-offer spreads have increased almost 10-fold since liquidity became an issue, widening from five basis points to 40 to 50 basis points. Bid-offer spreads reflect the prices investors are willing to pay for assets versus the price issuers are willing to accept. Kotze adds:

“Money markets are also seeing banks quoting wider prices than usual and there has been almost no (from what we can see) trading in corporate credit.”

Futuregrowth head of listed credit Tarryn Sankar goes as far as saying the credit market has essentially closed for business, with a series of primary issuers having cancelled coming to market over the last week. In the secondary market, she adds, it appears that there are lots of sellers and very few buyers.

She views the Reserve Bank’s actions last week as having helped from an overnight liquidity perspective, but says term liquidity remains a challenge. Internationally, banks have countercyclical buffers they can draw on. However, in South Africa, the regulator has never imposed a requirement for the local banks to build up buffers like these that they can run down in a market that is seizing up. Buffers are typically built up during times of economic strength, to be “used” in more troubled times. Given that SA has seen a prolonged period of low economic growth, we have never really had the opportunity, she says.

What else is there that the SARB could do to restore equilibrium to local fixed income markets? Kotze says he would have liked to have seen the Bank reduce the reserve requirement and embark on quantitative easing – in what would be the first programme of its kind in South Africa.

Sankar isn’t convinced that a reduction in the reserve requirement would be effective at a time when consumers are unlikely to spend when they are in lockdown and thus the expansion in money supply would not bolster economic activity as intended.

More aggressive actions by the Bank would, however, bring South Africa more in line with developed markets who have faced similar liquidity constraints. The European Central Bank President Christine Lagarde has committed to doing what it takes to ensure the effective functioning of the money markets and, in the latest co-ordinated move, the Federal Reserve has committed to engaging in QE “in the amounts needed” to support the flow of credit to employers, consumers, students, businesses and municipalities. After last night’s presidential speech, the SARB has joined the ranks of those publicly committing to do what it takes. 

As Kotze says, it is time for the SARB to be bold and not miss the opportunity to take advantage of the monetary policy space that has opened up as a result of developed markets letting go of the monetary policy reins and taking official interest rates down close to, or into, negative territory.

Sankar considers a combination of therapeutic policy measures, with monetary policy expansion accompanied by significant fiscal support to likely be more effective – a route that developed market governments are now taking after encouragement by central bankers to come to the party. BM

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