Examining the Sources of Sovereign Risk for South Africa: A Time Varying Flexible Least Squares Approach

Abstract

This paper analyzes the determinants of the South African long-term sovereign bond yield spread using 10-year bond yield spread. We employ the Auto-Regressive Distributed Lag and Flexible Least Squares techniques to demonstrate the impact of macroeconomic and financial variables on the yield spread. Our results show that the short-term interest rate is positively related to the bond yield spread both in the short and long run. We also establish a long-run positive influence of government debt on the bond yield spread whilst on the other hand, economic growth, the nominal effective exchange rate, stock market returns and bank credit all have a negative impact on the bond yield spread in the long run. We examine the time varying coefficient of government debt and reveal that the long-run impact of government debt has varied over the period under analysis. Time varying coefficients capture some important periods in the history of the South African economy, indicatingthat underlying economic conditions and exogenous shocks influence the determination of sovereign risk. Our results imply the need for synchronization of fiscal and monetary policy. In addition, economic policy should address economic growth and macroeconomic instability to complement deleveraging efforts aimed at curbing sovereign credit risk.