The impact of debt service costs and public debt on private capital formation in South Africa

Sheunesu Zhou

African Journal of Economic and Management Studies, 2021, vol. 12, issue 3, 453-469

Abstract: Purpose - The aim of this paper is to analyse the relationship between public debt, corporate debt service costs and private capital formation in South Africa. Design/methodology/approach - To capture the long-run characteristic of investment, the study adopts the Fully Modified Ordinary Least Squares approach and tests for cointegration using Hansen (1992)'s Parameter Instability test. Findings - We find that private capital formation increases in domestic debt and decreases in external debt during the pre-crisis period. However, during the period post the Global Financial Crisis, we find evidence of domestic public debt crowding out private capital formation, whereas external debt crowds-in capital formation. Debt service costs are found to reduce investment due to the effect of the debt overhang throughout the period under analysis. Research limitations/implications - The paper has important implications for macroeconomic policy. In particular, there is need for deleveraging and allocation of a higher proportion of debt to public infrastructure expenditure which has complementary effects on private investment. Practical implications - Debt overhang signal that South African firms could be over-leveraged, which hinders future growth prospects. Firms that face high levels of debt should consider debt restructuring. Originality/value - Empirical studies undertaken to explore this relationship have yielded contradicting results suggesting that the relationship between public debt and private investment is heterogeneous depending on a given economy or prevailing macroeconomic environment. In particular, existing research does not provide evidence on whether recent increases in public debt in South Africa have led to crowding-in or crowding-out of private investment. This paper therefore contributes to empirical literature on the impact of public debt on private investment within a small open economy.

Keywords: Cointegration; Public debt; Fully modified OLS; Private investment; Debt service ratio (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eme:ajemsp:ajems-01-2021-0024

DOI: 10.1108/AJEMS-01-2021-0024

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