South Africa and Investor Appetite: What’s the Empirical Connection Between Different Types of Geopolitical Risk and Bond Spreads?

Morgan Stanley analysts project a significant improvement in South Africa’s fiscal balance, expecting the consolidated deficit to narrow to 3.5% of GDP by March 2027 and the primary surplus to widen. This improved outlook has driven a rally in South African assets, with 10-year bond yields dropping over 300 basis points and further sovereign spread compression anticipated. Read the full story at Bloomberg.

This is a well-known empirical relationship in international finance, particularly for markets like South Africa.

In broad terms, as a government’s fiscal balance improves (moving toward a surplus or a smaller deficit), its bond spreads typically narrow. This occurs because a healthier fiscal position reduces the perceived default risk, leading investors to demand a lower risk premium.

Indeed, studies across both advanced and emerging economies show that widening deficits and rising public debt levels significantly push bond yields and spreads higher. However, while the general relationship is strong, empirical literature highlights a few critical qualifiers:

Markets differentiate between types of deficits. Deficits driven by government investment (e.g., infrastructure) may decrease long-term yields, whereas those driven by current expenditure (e.g., public wages) are penalized more heavily by investors.

While local fiscal fundamentals are crucial in the long run, short-term fluctuations in spreads are often driven by global financial volatility and risk aversion.

Finally, the impact of fiscal policy on yields is stronger when a government relies heavily on domestic banks for deficit financing, as is the case in South Africa, where domestic holdings of government debt have risen significantly.

Where does the ICRG research come into play? While general economic theory links fiscal balances to spreads, the ICRG provides the specific empirical metrics that investors and researchers use to measure this link.

Recent ICRG-based research specifically quantifies how a country’s risk rating impacts its borrowing costs: For example, a 10-point deterioration in a country’s ICRG risk rating (indicating higher risk) is associated with an average annual increase in sovereign spreads of 106 basis points. This effect is significantly more pronounced for countries with high debt levels.

Moreover, the same 10-point drop in risk rating is also linked to an average reduction in GDP growth of two percentage points.

Historical ICRG data shows that while South Africa’s financial risk may occasionally appear stable, its political and economic risk rankings often sit in the lower-middle field globally (e.g., around 75th–78th place), which keeps spreads elevated.

Because ICRG data is updated monthly and has been shown to be predictive of future debt returns, bond markets often react to shifts in these risk scores before official credit rating changes occur.

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The PRS Group

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CHRISTOPHER MCKEE, PHD CHIEF EXECUTIVE

Christopher McKee is PRS’ CEO and Owner. An international political economist, global investor, entrepreneur, and author, Chris received his PhD from Queen’s University (Canada) and has been involved in the field of geopolitical risk, limited recourse financing, and private sector development for the past 25 years.