Driving the fiscal borrowing agenda

Jo-Maré Duddy – Government has ensured that it will be able to raise about N$7 billion from the domestic market in 2019/20 by compelling local pension funds to invest 45% of their total assets in Namibia.

Whether this will pay off for investors in the long term, only time will tell, local analysts agree.

Finance minister Calle Schlettwein last year gazetted regulation 13 of the Pension Fund Act, stipulating that pension funds had to invest 40% of their total assets locally by the end of August 2018. This figure was increased to 42.5% by the end of November and at the end of March this year, it was upped further to 45%.

Regulation 13 repealed regulation 28, which was first introduced in 1994, pinning the minimum requirement of pension funds’ local investment at 10%. In 2014, this was increased to 35%.

Figures released by the Namibia Financial Institutions Supervisory Authority (Namfisa) recently showed the investment of the local pension fund industry in different asset classes at the end of March 2019 totalled nearly N$167.8 billion. Of this, 40.33% - or around N$67.7 billion - was Namibian investments.

Should the industry have met the required threshold of 45%, approximately N$75.5 billion would have been invested in Namibian instruments. That means that about N$7.8 billion of the industry’s assets is still looking for a local investment home.

At a press conference recently, Schlettwein said government’s borrowing requirement for 2019/20 stands at N$10.1 billion, of which N$7.1 billion will be sourced from the domestic market. That will bring government’s estimated domestic debt for the current fiscal year to about N$61.4 billion, up nearly 12% from 2018/19.

Domestic debt is projected to make up nearly 63.8% of government’s total estimated debt of about N$96.3 billion in 2019/20.

“The N$7.1 billion will be raised through instruments ranging from 1 years to 30 years of maturity and based on the market/investor demand,” Schlettwein said.

Increased demand

“The higher local asset threshold has undeniably increased the demand for government bonds, which is evident in higher bid to offer ratios and declining spreads over the benchmark South African bonds,” says Dylan van Wyk, researcher at IJG Securities.

According to Eloise du Plessis, research chief at PSG Namibia, regulation 13 has “likely had the effect of driving pension and long-term assets into government bonds and cash”.

Megameno Shetunyenga, researcher at Simonis Storm (SS), says the “only sizable and available investments right now” are fixed income investments like government bonds and treasury bills.

“Whether they are quality investments, that is debatable and only time will tell,” Shetunyenga says.

Although fixed income returns are currently “still quite attractive”, it is “certainly not sustainable in the long term given the pressure on the economy and our country’s fiscal position”, he says.

Van Wyk says the increased demand for government bonds stemming from regulation 13 is evident in higher bid to offer ratios and declining spreads over the benchmark South African bonds.

“Higher competition for these assets have led to lower average yields on auctions, decreasing the returns on these investments for future investors,” he says.

Returns

The expected return on fixed income investments are lower than that of equity, given the lower level of risk, according to Van Wyk.

“Thus, pension funds targeting higher returns will have a more difficult time finding assets to meet their objectives,” he says.

This is especially troubling for defined benefit funds, he points out. A defined benefit funds is a type of pension plan in which an employer promises a specified pension payment retirement that is predetermined by a formula based on the employee's earnings history, tenure of service, age, ect., where liabilities are independent of underlying asset returns.

“Essentially, if pension asset returns are lower than the growth in pension liabilities, the employer will have to make up the shortfall through additional contributions,” Van Wyk says.

The Government Institutions Pension Fund (GIPF) is a defined benefit fund and is the biggest player in the local industry. At the end of 2017, N$110 billion of the industry’s total assets of N$152 billion belonged to the GIPF.

“At this stage, performance is still ahead of the target of the consumer price index (CPI) plus 3%,” Du Plessis says.

However, she points out: “Assets need to be allocated to keep up with this target, so the risk of underperforming lies with the GIPF itself. They will need to allocate assets to investments outside the 45% that will still ensure that the liabilities can be met.

“If that growth is still not enough, contributions will have to increase, which comes from taxpayers. The pensioners of the GIPF do not carry the risk,” Du Plessis says.

The other pension funds in Namibia are “very small” compared to the GIPF and are mostly defined contribution funds, she says. This means that the risk of underperformance is “squarely on the shoulders of the members of the fund”.

“In my opinion, it is these members that will see the effect of lower-growth assets the most,” Du Plessis says. “The asset managers only has the responsibility to perform in line with the benchmark, which already takes account of the 45% requirement in Namibia.”

‘Artificial demand’

Van Wyk says the issue with increasing the local asset requirement is that artificial demand can be created for government bonds by increasing the local asset requirement.

“As government borrowing requirements increase, the domestic asset requirements can be systematically increased to ensure demand for the debt.

“Theoretically the local asset requirement can be increased to 100%, until all pension fund assets are invested locally. Although this is an extreme scenario, there has to be some balance between investing money at home and earning the best possible risk adjusted return for pensioners,” Van Wyk says.

Regulation 13 will “absolutely” make it easier for government to borrow domestically, Shetunyenga says.

This in itself is “not a bad idea, given that risks are minimal when a government borrows via its local market”. “However, any unsuitable borrowing (whether local or foreign) could and will put the country’s future economic well-being at risk,” he says.

“Borrowing that produces enough economic benefit to pay for itself is considered a good thing. Hence, the question to ask is rather whether the past and current government borrowings will produce enough economic benefit to pay for itself. We certainly do not concur,” Shetunyenga says.

Market

Asked whether there are enough quality investments in Namibia which could absorb the extra money resulting from regulation 13, Shetunyenga answered: “Definitely not.”

The lack of local assets has been a bit of a headache for many fund managers, especially those with high equity mandates or higher targeted returns, Van Wyk says.

“Although there is sufficient fixed income assets, mostly in the form of government debt, corporate debt and bank deposits, there is definitely a lack of riskier assets such as listed and unlisted equity,” he says.

Additionally, Namibian equities lack the diversification benefits that foreign markets can offer, seeing as there are only ten locally listed equities on the Namibian Stock Exchange (NSX) and a handful of dual-listed stocks. Furthermore, dual-listed stocks’ local asset status have also been capped at 10%, so equity options are quite limited, Van Wyk says.

Du Plessis points out that the weak uptake of the recently Oryx Properties rights offer and the initial public offering (IPO) of Letshego Namibia in 2017 indicates that pension fund managers are not “desperate” for Namibia equity assets.

Shetunyenga also points out that local investment opportunities on the equity front are “very limited especially in the listed space”.

“However, there are prospects of further listings on the local stock exchange which is positive and will create avenues where funds could be deployed,” he adds.

In this regard, state-owned MTC recently announced that it will start formal procedures and is likely to list on the NSX next July. Bidvest Namibia, however, is expected to delist on the Local Index of the NSX this month following a take-over offer from the JSE-listed Bidvest Group in South Africa.

Shetunyenga says there are opportunities available in the unlisted space, like the infrastructure sector. “However, whether they will generate sufficient return than investment outside Namibia, certainly requires time and an enabling economic environment,” he says.

One of the benefits of the new regulation is that it forces a deepening of the Namibian capital markets, Van Wyk says.

“Because assets are so scare, this should incentivise more companies coming to market to raise equity and debt capital though initial public offerings and medium term note programmes,” he says.

Shetunyenga adds: “The fact of the matter is we need the economy to start growing again and this can only be attained through having structural reforms.”

According to him, these reforms include: policies certainty and a business friendly environment, increasing efficiency in the public sector, reforming state-owned enterprises, improving capital allocations and strategic service infrastructure, and attracting the relevant talent and skills.