Abstract
D.Comm.
Foreign debt affects the economy through three main channels, namely: the
debt overhang effect, the liquidity constraint effect and the uncertainty effect.
The main aim of this study is to derive an optimal level of foreign debt relative
to Gross Domestic Product (GDP) for South Africa by investigating these
channels. Incurring foreign debt is like a double edge sword. On the one side
the foreign debt is needed for economic development (from a demand perspective)
and on the other side the level of debt impacts on the economy
through higher domestic interest rates, via the sovereign risk spread, (from a
supply perspective). The factors that impact on capital flows as shown by previous
periods of financial distress in the global capital markets and debt sustainability
were investigated.
This study shows that risk spreads are driven by both internal and external
factors. Investors will price into the secondary risk spread their perceptions of
the sustainability of foreign debt. This is also impacted by external factors
such as contagion and the credit rating of a country. The different objectives
of government in the internal capital market since 1994 and the secondary objectives
of building liquidity benchmarks, diversifying the foreign currency portfolio,
broadening the investor base in RSA bonds and borrowing at the most
effective rates, are also discussed.
A number of equations were estimated using the Ordinary Least Squares
(OLS) method and the values for government foreign debt were varied to test
the impact on the familiar IS/LM/BP and AS/AD models. These models were
further used to determine the debt overhang and liquidity constraint effect. It
was found that foreign debt has an asymmetric impact on economic growth
where it contributes to economic growth up to a level of approximately 35 per
cent of GDP, where after it has a negative impact on economic growth.