Investigating why Namibian bonds are outperforming South Africa’s

Namibian government bonds have been performing remarkably well over the last 18 months. Since the start of 2023 these bonds have provided a composite return (as reflected by the IJG All Bond Index) of 12.6% on a total return basis (including coupons), compared to the South African government bonds, which returned only 3.9% over the same period. This more or less mirrors what we saw in 2022, when the Namibian sovereign bonds returned 8.4% versus a 4.2% return by South Africa’s government bonds. Namibian bond yields have strengthened to the point where Namibian yields are lower than those of our southern neighbour.

What makes this particularly interesting is the fact that Namibian bonds are benchmarked against those of South Africa. South African bonds are used as a benchmark due to the strong monetary ties between the countries and the fact that South African bonds are more liquid and thus prices, and yields, are more accurate. The yield to maturity of our domestic bonds is calculated based on the yield of a comparable South African government bond, with an additional spread factored in. This yield to maturity represents the anticipated total annual return for investors if the bond is held until its maturity date, assuming all coupon payments are made on time and reinvested at the same rate.

The spread that is added on top of the equivalent South African bond’s yield to derive the Namibian bond’s yield signifies the extra yield (or return) that investors require for taking on the additional risks associated with lending money to the Namibian government over those of lending to the South African government. A wider spread indicates higher perceived risk, while a narrower spread suggests lower perceived risk. Investors demand a higher return for investing in Namibian bonds compared to those of South Africa due to the perceived higher risk that Namibia might not repay its debt (default risk) as well as the lower ease of selling the bond again (lower liquidity) compared to South African bonds. This higher return compensates for these perceived risks.

Over the past 20 months, domestic bond spreads have been decreasing, indicating that investors are willing to accept lower returns and pay higher prices for Namibian bonds, which has led to these bonds outperforming their South African counterparts. One of the main reasons we have been seeing this play out is due to supply and demand dynamics. Basic microeconomic theory teaches us that when demand for a product goes up, its price tends to go up, and vice versa. Conversely, when the supply of a product increases, its price tends to go down as it is less scarce, and intuitively, when supply decreases, the price tends to go up.

At the start of the government’s financial year, the Ministry of Finance announces what the country’s funding shortfall will be for the year and how much debt the government will issue to fund this budget deficit. In February this year, the Ministry of Finance announced that the funding requirement for 2023/24 would amount to N$10.08 billion, a material decline from the N$19.38 billion funding requirement in 2022/23. The Ministry projected that budget deficits would continue to narrow over the medium term to around N$9.15 billion in 2025/26. Lower funding requirements signal an improving fiscal situation, as smaller government deficits reduce the need to borrow, resulting in fewer bonds being issued.

The demand for Namibian government debt is largely driven by regulatory requirements for domestic assets imposed on pension and insurance assets. These requirements state that 45% of the country’s relatively large non-discretionary savings pool (retirement and insurance funds) has to be invested in domestic assets. A lack of domestic assets available to invest in has resulted in government bonds making up the largest asset class available for such investment. This has led to a consistent demand for government bonds. On average, demand for domestic government bonds at auctions has exceeded supply by around 4.5 times since the start of 2023. By comparison, demand was 2.6 times higher than the available supply in 2022 and 2.0 times higher in 2021.

Rising global interest rates, coupled with the welldocumented economic challenges faced by South Africa in recent years, have resulted in South African bond yields rising considerably. Since Namibian bonds are priced relative to their South African benchmarks, the higher yields that investors were requiring on SA bonds meant that Namibian bonds were trading at particularly attractive levels, further increasing demand.

Another reason for the lower spreads, and relative outperformance of Namibian bonds, has been the positive investor sentiment that followed after last year’s oil discoveries. While it is expected that Namibia will only be producing oil in 8-10 years’ time, the country should start seeing the economic benefits long before in the form of increased foreign direct investment. Investors are at present expecting the government’s fiscal situation to improve dramatically in the future on the back of expected royalties and taxes, which reduces the perceived risk of lending money to the government and results in lower required returns. Coupled with the reduction in supply and relatively steady demand, these developments have resulted in a significant rerating of Namibian government bond yields.

At this point it is worth mentioning that past performance is not an indication of future returns. There is no guarantee that Namibian bonds will continue outperforming South African bonds going forward, especially since spreads have already contracted materially over the last 20 months. Still, Namibian bonds have delivered impressive performance for investors over this period, driven by the unique supply and demand dynamics of the Namibian bond market.

Danie van Wyk – Head: Research, IJG Securities

IJG believes in tailoring their services to a client’s personal and business needs. For more information, visit www.ijg.net