Investors have flocked to South Africa's domestic bond markets, betting the country can stay the course on reforms despite political fractures, but tariff threats and the prospect of a global growth slowdown are casting a long shadow.

Africa's most industrialised nation depends on foreign investor support to manage its debt load and to keep borrowing costs in check as it faces persistent structural challenges, including unreliable electricity and governance issues that have weighed on its assets in the past.

"We view recent developments in the US trade policies as a material risk to the growth and inflation outlook," said Thierry Larose, portfolio manager at Vontobel Asset Management, which holds domestic government bonds.

"We see the weaker US dollar as the only meaningful tailwind for local assets."

Investor interest in domestic bonds has held up well so far. Treasury data shows non-resident holdings of local-currency bonds rose January through March to 25%, the highest since October. Data from the Institute of International Finance shows the nation drew $2.8-billion in fixed income inflows between December and March compared to outflows in Asia and a more mixed picture in emerging Europe and Latin America.

Performance was more patchy. Domestic currency bonds though have underperformed, losing 0.3% since January versus a 2.9% gain in the JPMorgan GBI-EM benchmark.

Meanwhile, South Africa's hard-currency bonds have outperformed Sub-Saharan African peers this year, losing 1.5% compared to a 3.3% drop across the broader Africa index.

DOUBLE WHAMMY

It's been far from a smooth ride for investors.

Markets initially turned from gloom over political uncertainty to optimism after last May's election, which forced the African National Congress (ANC) into coalition with rival parties widely seen as business-friendly.

But tensions within the alliance spilled into public view in February, as the ANC and the Democratic Alliance (DA) clashed over tax and foreign policy, fuelling doubts about the coalition’s staying power.

At the same time, US President Donald Trump threatened sweeping new tariffs on nations around the world with his policy decisions broadly expected to stymie growth. For South Africa, this is a worry.

"South Africa has always had greater economic integration with the rest of the world and foreign ownership is pretty meaningful, so that has contributed to a relatively high beta to the global economic cycle," said Andrew Matheny, managing director, economics research at Goldman Sachs International.

The latest turmoil sent the rand tumbling to near-record low, before recovering to trade flat on the year.

Grant Webster, co-head of emerging markets sovereign and FX at Ninety One, which is bullish on both domestic and international South Africa bonds said "structurally weak growth, high debt, and the increase in domestic political noise in addition to extreme global economic and geopolitical uncertainty" dampened his outlook on the country.

JPMorgan has kept a neutral position on both the currency and local bonds, saying the latter was back at fair value and the near-term risk of a large selloff had fallen, though flagged that external recession risks were the biggest factor to watch.

And domestic politics might still throw a spanner in the works. A collapse of the government could affect investor confidence and policymaking, especially if the ANC must then rely on smaller parties to govern, Fitch Ratings said. But likely new coalition partners — such as ActionSA and Build One South Africa — support the fiscal framework. Downside risks from politics are already captured in its projections, said Thomas Garreau, Director at Fitch.

TARIFFS LOOM

South African policymakers are trying to reassure markets,

The US makes up just 8% of exports — and a large chunk of the shipments are in precious and base metals, already exempt from the Trump tariffs. National Treasury said the direct impact of the levies would have been limited.

"Even under a full AGOA exclusion scenario, the GDP impact would be marginal — around 0.07%," the National Treasury told Reuters, referring to the African Growth and Opportunity Act, a US flagship trade programme for the continent.

"However, certain sectors such as agriculture, construction, and retail would face disproportionate harm."

In the meantime, domestic reforms continue.

Revenue collections exceeded estimates for 2024/25, helping narrow the main budget deficit, Treasury said, adding it was busy engaging with ratings agencies and investors.

Meanwhile investors will be closely watching a review by ratings agency S&P Global Ratings, scheduled for May 16. S&P currently holds a positive outlook — signalling potential for an upgrade if fiscal and reform progress holds - its first such move in two decades.

"Recent political developments have not fundamentally changed our outlook for South Africa," said Lucie Villa, Senior Vice President at Moody’s Ratings.

However, she warned there "are increasing downside risks due to the direct and indirect impacts of US tariffs and political disagreements within the coalition on fiscal and economic policy."