Global Growth and Financial Spillovers and the South African Macro-economy

Since 2007, South African economic growth has weakened and become volatile following a sequence of unexpected global shocks. These began at the onset of the global financial crisis in 2007, continued with the subsequent global recession in 2008 and upon the onset of the euro area sovereign debt crisis and the implementation of unconventional monetary policies. The empirical assessment and quantification of the effects of these adverse shocks emanating from advanced economies is important for both policymakers and researchers. It is necessary for policymakers to understand the nature of these unexpected shocks and disentangle whether the spillover is directly and indirectly transmitted into the South African economy. The various channels have not been explored in detail, and it is the objective of this book to analyse these effects. Is the South African economy vulnerable to external shocks, and if so, in what way? How does the economy respond to these shocks, which manifest themselves as the unexpected changes in global economic growth, global risk perceptions and financial spillovers?

Chapter 2 focused on the susceptibility of the South African economy to GDP growth shocks emanating from G8 countries. However, is it also possible that South Africa’s economic growth is exposed to the direct and indirect effects from economic growth impulses from Brazil, Russia, India, and China (BRIC) countries? This chapter (1) analyses the contribution of BRIC member countries’ GDP growth shocks to South Africa’s economic growth dynamics; (2) determines the channels of transmission; and (3) establishes whether the third–country effects channel exists. We perform a counterfactual analysis to determine the amplifying abilities of some channels on South African growth response to BRIC growth shocks.

In the previous chapters the analysis was limited to the role of external positive GDP growth shocks transmitted into South Africa (SA). The United States Federal Reserve (US Fed) lowered its policy rate to the zero lower bound and embarked on various rounds of quantitative easing (QE) aimed at stimulating and supporting economic activity. We presented evidence that the two rounds of QE had spillover effects on the South African economy. In this chapter, the analysis is extended and investigates the extent to which unanticipated increases in the US Federal funds rate (FFR), bond yields and monetary aggregates affect the South African exchange rate, bond yields and real short-term interest rates. Based on the expected FFR normalisation, what are the potential implications for the South African real interest rates and rand per US dollar exchange rate?

The euro area borrowing costs increased significantly during the sovereign debt crisis period, which still rages on. The crisis could spillover into emerging markets which are classified as vulnerable, including South Africa. We showed in preceding chapters that SA is exposed to the external environment.

Evidence in the preceding chapters highlights the effectiveness of several channels in transmitting external growth shocks and financial shocks to impact the South African economy. This chapter analyses the effects of net capital flows following the episodes of increased global liquidity linked to unconventional monetary policy interventions. To what extent do capital inflows shocks impact asset prices, and what are the effects on domestic monetary policy and financial stability? What would have happened to South African macroeconomic variables in the absence of net capital inflow shocks? Is the role of capital inflows on import dynamics and on the relative asset prices values to their replacement cost in the residential sector well understood? We attempt to answer these questions.

Chapter 6 examined the effects of various categories of capital inflows on South African financial and real economic activity. However, various studies in the literature have shown that the aggregation of capital flows may not reveal the different effects of inflows and outflows. We define inflows (outflows) refer to capital movements of liabilities (assets) of a country. This chapter assesses the effects of unexpected positive portfolio inflows and outflows shock on South African financial and real economic activity variables. What would have happened to South African GDP growth in the absence of the portfolio inflow and outflow shocks? What do counterfactual scenarios suggest the impact of portfolio flow shocks is on the exchange rate?

The previous chapter examined the effects of capital flows on South African financial and real economic variables. This chapter analyses the effects of investment flows and the exchange rate depreciation effects on the trade balance, and then relates this to capital inflows into South Africa. Does the exchange rate depreciation, an unexpected investment slowdown related to the deterioration in balance sheets reinforce or offset each other’s impact on the trade balance? Theory postulates that the trade balance can be defined in two ways namely; (1) the trade balance can be expressed as the difference between national savings and investment or (2) as a gap between exports and imports. In the first definition, the decline in investment through the investment savings (IS) relationship is an important cause of the trade balance reversals. In the second expression, the exchange rate is a major determinant of the trade balance dynamics. Fluctuations in the exchange rate affect both the price and volumes of imports and exports. As a result, when the price effects of the changes in the exchange rate dominate the volume of exports and imports, the exchange rate depreciation is expected to lead to a J-curve response in the trade balance.

In Chapter 4 we established that growth spillover effects from Brazil, Russia, India and China (BRIC) to South Africa are also transmitted via the financial channel. We also examined whether the stock price channel amplified BRIC growth shock effects into the South African economy. However, we did not assess the stock market intercon-nectedness. In this chapter we assess the extent to which the South African, Brazilian and Indian equities markets are interdependent. This interconnectedness can be a source of financial contagion effects and instability. A large body of empirical studies provides evidence on the co-movement of equities markets. Furthermore, stock returns seem highly correlated with future real economic activity. We begin the discussion by showing the trends of the daily stock market prices in Figure 9.1 (a) to (d). We present the rolling windows of correlations between the Johannesburg Stock Exchange (JSE) All-share price index (Alsi), the Bovespa stock market index and the Bombay stock market index.

We construct a financial stress index (FSI) and assess its effects on South African economic activity. Stress in the financial markets played a significant role in propagating the effects of the financial crisis and in limiting the effects of monetary policy stimulus. To explore the possibility of policy coordination, we investigate the following questions: Does financial stress impact the monetary policy reaction function? Is there evidence suggesting that monetary policy responded aggressively or passively during periods of elevated financial stress? We begin the analysis by assessing the relationship between global risk as proxied by VIX and South African financial variables. The simple relationship between VIX and some South African financial variables is shown in Figure 10.1 (a) to (f).

This book set out to quantify the impact of global financial and growth spillovers into the South African economy. We use a combination of statistical and econometric approaches to establish the nature of the relationships, quantify the extent of the impact and derive policy implications.