An analysis of sovereign risk in South Africa with the focus on fiscal determinants

Abstract

This paper investigates the sovereign risk premium as an indicator of sovereign risk. An attempt was made to capture evidence that best explains bond yield spreads for the 21-year period after the inception of democracy in South Africa in 1994. Conventional unit root testing techniques were applied, and the results revealed unit roots at monthly, quarterly and annual frequency, warranting further econometric testing. The fi nancial crisis in the period 2007 to 2011 posed a potential signifi cant break in data and was built into the analysis. The results for the crisis period differed substantially from the pre- and post-crisis period and are reported as such. The results reveal a unique combination of explanatory factors (cointegration), but also a special implication for bond yield spreads. They re-affirm the importance of fiscal policy decision making and fiscal balance, taking all factors into account such as long-and shortterm interest rates. Current spending and the public sector borrowing requirement have a statistically positive effect on spreads depending on whether they were pre- or post-crisis. The latter could be an indication of investor sensitivity, especially in terms of the way in which the borrowing requirement is utilised and the fact that capital formation is preferred to current spending. Furthermore, the maturity of domestic debt shows up as statistically negative, probably confirming investor interest and thus confidence in the long run, with possible consequences for financial stability as a regional public good.

Key words: policy, sovereign risk, spreads, bond markets