Can public debt stimulate public investment and economic growth in South Africa?

Abstract

South Africa is a developing country faced with diverse challenges like high unemployment, poverty, inequality and low economic growth. In an attempt to address these issues, government can embark on borrowing and incur public debt. Countries that run large persistent public debt signal negative perceptions to investors as the debt might lead to credit risk posed by currency weakness and credit downgrades. The study investigated if public debt can influence public investment and ultimately economic growth. The autoregressive distributive lag, Granger causality, impulse response function and variance decomposition were applied to achieve the objectives. The cointegration test has found the existence of long-run relationship among the investigated variables. It turns out that in the long run there is a negative relationship between public debt and investment. Since there is direct link between investment and economic growth, there is an inverse relationship in the public debt economic growth nexus. The error correction mechanism confirmed that the system can adjust to equilibrium at a speed of 17%. There is bi-directional Granger causality relationship between public debt and economic growth. The impulse response function has found that, one standard deviation shock in public debt inversely affect economic growth. Variance decomposition results indicate that a shock to public debt account for 16.39% fluctuations in economic growth. It is recommended that a capital scarce country be encouraged to borrow so that more capital can be accumulated. However, the later stage of borrowing marked with high level of debt will lead to subdued growth.

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