Foreign debt boosts growth while domestic borrowing drags South Africa’s economy

A new study published in Economies offers critical insights into South Africa’s long-standing public debt dilemma. Titled “An Asymmetric Analysis of the Impact of Foreign and Domestic Debt on South Africa’s Economic Growth” by Gisele Mah of North-West University, the research deploys the Nonlinear Autoregressive Distributed Lag (NARDL) model to uncover how domestic and foreign debt asymmetrically affect GDP growth.

Drawing on annual data from 1960 to 2023, the study reveals a complex and often counterintuitive relationship between debt types and national income, with significant implications for debt management strategies in post-COVID South Africa.

How do domestic and foreign debts differ in their impact on growth?

The research distinguishes the effects of foreign and domestic debt, emphasizing that they are not interchangeable in their implications for economic performance. The findings suggest that domestic debt has a largely detrimental effect on GDP, while foreign debt, under certain conditions, can support economic growth.

Specifically, an increase in domestic debt negatively affects GDP in the long run. For every unit increase in domestic debt, GDP declines by 0.23 units. Conversely, a reduction in domestic debt significantly boosts economic performance, each unit decrease leads to a 0.69 unit rise in GDP. The results suggest that GDP in South Africa responds more strongly to a reduction in domestic debt than to an increase.

In contrast, foreign debt shows the opposite trend. An increase in foreign debt correlates with a statistically significant rise in GDP. Each unit increase in foreign debt boosts GDP by approximately 2.21 units. However, a decrease in foreign debt leads to a drop in GDP, although this effect is statistically insignificant.

These findings underscore that not all debt is created equal. Domestic debt, often used to cover primary deficits and bail out struggling state-owned enterprises like Eskom and South African Airways, tends to be costlier and less efficiently allocated. By contrast, foreign debt typically comes with lower interest rates and external discipline mechanisms that encourage better macroeconomic management.

Are these effects symmetrical in the short and long run?

The study's use of the NARDL model allowed the author to distinguish between short-run and long-run dynamics, offering a nuanced understanding of asymmetrical effects.

In the long run, the asymmetries are pronounced. Domestic debt exhibits strong asymmetry, reductions in domestic debt significantly improve GDP, while increases hurt it. Foreign debt, meanwhile, shows that only increases have a statistically meaningful positive impact; reductions do not significantly affect GDP.

In the short run, the results are mixed. A positive shock in domestic debt shows a temporary boost to GDP, suggesting that short-term increases in domestic borrowing may offer transient benefits. However, lagged positive changes in foreign debt were found to be significantly negative, contradicting the long-run positive effect. This indicates a potential short-term volatility introduced by foreign borrowing, possibly due to currency mismatches or immediate repayment obligations.

Additionally, dummy variables representing structural breaks in 2009 and 2020 (notably aligned with global financial disruptions and the COVID-19 pandemic) were found to exert negative impacts on GDP in both short and long runs, reaffirming the role of external shocks in shaping debt-growth dynamics.

The Wald test results confirm the statistical significance of these asymmetries in both debt types and time horizons, strengthening the case for differentiated and adaptive policy approaches.

What are the policy implications for South Africa’s fiscal strategy?

The study presents clear policy signals. For domestic debt, fiscal authorities are urged to prioritize reducing reliance on internal borrowing, especially when such funds are funneled into inefficient and fiscally destabilizing programs. South Africa’s domestic debt is associated with higher borrowing costs, reduced investor confidence, and crowding out of private investment. As the government typically borrows at premium interest rates due to risk perceptions and a shallow savings base, domestic debt becomes an increasingly unsustainable instrument.

Therefore, the author advocates for domestic debt management that focuses on:

• Lengthening the maturity profile of debt,
• Deepening capital markets,
• Enhancing fiscal transparency,
• Reducing the need for frequent bailouts of state entities, and
• Boosting the overall efficiency of public spending.

For foreign debt, while the research supports its positive contribution to economic growth, it urges caution. Policymakers are encouraged to:

• Limit exposure to high-cost commercial debt,
• Pursue concessional borrowing from multilateral institutions,
• Strengthen institutional capacity to manage external obligations, and
• Integrate debt policy within a broader macroeconomic stability framework.

The study also highlights the necessity of maintaining investor confidence through transparent reporting and consistent debt servicing. Given that foreign debt positively influences GDP mainly through its role in financing growth-oriented projects, the optimal use of these funds becomes critical.

The author calls for further research into additional macroeconomic factors such as exchange rate volatility and governance, which could mediate the debt-growth relationship. Expanding the study to a provincial panel data framework is also proposed to better understand regional disparities and policy needs.