Global Growth and Financial Spillovers and the South African Macro-economy Mthuli Ncube Professor of Public Policy, Blavatnik School of Government, University of Oxford Nombulelo Gumata Economist, South African Reserve Bank and Eliphas Ndou Economist, South African Reserve Bank and Lecturer, University of the Witwatersrand, South Africa nilian
Contents List offigures ListofTables Preface Acknowledgements xi xvii xviii xxi 1 Introduction 1 1.1 Stylised facts 2 1.1.1 What happens to the exchange rate and asset prices at peak and low levels of global risk aversion? 2 1.2 Do foreign and South African asset prices move together? 4 1.3 The relationship between G7 economic growth and South African growth 5 1.4 Correlation between South African trade variables and G7 economic growth 6 1.5 Are South Africa's export shares following global economic growth dynamics? 8 Part I Growth Spillover Effects 2 Positive Economic Growth Spillovers of G8 Countries into South Africa 13 2.1 Introduction 13 2.2 Recent growth spillovers evidence 17 2.2.1 Evidence on the regional sources of growth spillovers 17 2.2.2 Evidence of various Channels of transmission 18 2.3 Brief discussions of various economic linkages 18 2.3.1 Trade patterns 18 2.3.2 Foreign inward and outward Investment 21 2.3.3 The real effective exchange rate movements and implications for competitiveness 21 v
vi Contents 2.4 The methodology 22 2.4.1 The modified Poirson and Weber growth spillover framework 22 2.5 The empirical analysis 23 2.5.1 How does South African economic growth respond to positive GDP shocks from G8 countries? 23 2.5.2 Evolution of South African growth before, during and after the recession in 2009Q1-Q3? 25 2.5.3 The role of different transmission Channels 28 2.5.4 To what extent are US growth shocks transmitted via third countries? 30 2.6 Conclusion 31 3 Growth Spillovers from BRIC Countries into South Africa 33 3.1 Introduction 33 3.2 Dissecting the role of China on South African trade dynamics 36 3.2.1 The South African exports to China 37 3.2.2 The South African Imports from China 37 3.3 The methodology 38 3.4 The data 39 3.5 Empirical results 40 3.5.1 How did BRIC countries contribute to South African GDP growth during the recession in 2009Q1-Q3 and beyond? 41 3.5.2 The role of different transmission Channels 43 3.5.2.1 The counterfactual analysis of various Channels and third country effects 44 3.6 Conclusion 48 Appendix A3 48 Ordering sequence 48 Part II Spillovers of Foreign Financial Shocks 4 The Spillovers of Financial Shocks from the United States into the South African Economy 51 4.1 Introduction 51 4.1.1 The relationship between US and SA financial variables 52 4.1.2 The relationship between US trade with SA 54 4.2 Recent studies 56
Contents vii 4.3 VAR methodology 57 4.4 The results 59 4.5 Discussion of the results 59 4.5.1 Robustness analysis: does the sample size alter the responses? 60 4.5.2 Historical contributions 62 4.6 Conclusion 63 Appendix A4 65 Appendix B4 66 5 Spillovers from Euro Area Bond Yields into the South African Macro Economy 67 5.1 Introduction 67 5.2 Stylised facts on trade relations between South Africa and the euro area 68 5.3 A brief review of the portfolio balance model of the exchange rate determination 71 5.4 VAR methodology and the data 72 5.5 Findings 74 5.5.1 Responses to an unexpected positive euro area bond yield shock 74 5.6 What are the effects of selected unexpected positive euro area bond yields shocks? 76 5.6.1 Does the inclusion of the period of global uncertainty between 2008 and 2011 affect the results? 76 5.6.2 The counterfactual analysis using extended sample data 77 5.7 Conclusion 79 Appendix A5 80 Part III Capital Flow Effects and the Trade Balance 6 Capital Inflows and Asset Prices in South Africa 83 6.1 Introduction 83 6.2 Stylised relationships during the Inflation targeting period 84 6.3 Recent studies 88 6.4 VAR methodology 88 6.5 Data 89 6.6 What are the initial responses of variables on impact? 89 6.6.1 Empirical results 89
viii Contents 6.6.2 Counterfactual analysis of the role of shocks from capital inflows 91 6.6.3 Did the capital inflow shock impact Imports and exports? 93 6.6.4 The effects of capital inflows shocks on financial vulnerability indicators 95 6.6.5 Capital inflows and credit growth 95 6.6.6 Tobin's q of residential property and capital inflows 96 6.7 Conclusion 99 Appendix A6 100 7 The Effects of Portfolio Inflow and Outflow on the Economy 101 7.1 Introduction 101 7.2 Do net portfolio flows increase asset prices returns? 103 7.2.1 How do net portfolio inflows impact the exchange rate? 104 7.2.2 Relationship between portfolio flows and economic growth 105 7.3 VAR methodology 105 7.4 Results 106 7.4.1 What are the effects of a positive Inflation shock on various capital inflows and outflows? 106 7.4.2 Are outflows or inflows more responsive to an inflationary shock? 107 7.4.3 What are the effects of a contractionary monetary policy shock on capital flows? 107 7.4.4 What are the effects of positive portfolio outflow shocks? 109 7.4.5 What is the impact of positive portfolio inflow and other forms of capital inflow shocks? 110 7.5 Counterfactual analysis of the role of portfolio flows 110 7.5.1 Contributions of portfolio flows and domestic factors on asset prices 111 7.5.2 Portfolio flows versus asset price and domestic factors: counterfactual economic growth analysis 112 7.6 An unexpected positive interest rate differential shock on portfolio flows dynamics 113 7.7 Conclusion 114 Appendix A 7 115
Contents ix 8 Investment Flows and Exchange Rate Effects on the Trade Balance 116 8.1 Introduction 116 8.2 Further trend analysis 118 8.3 Theoretical linkages 120 8.4 VAR methodology 121 8.5 Findings 122 8.5.1 Does the evidence change when we add more shocks? 125 8.5.2 Which components of the trade balance transmit the shocks? 126 8.6 The historical and variance decompositions 127 8.7 Conclusion 128 Appendix A8 129 Part IV Equity Markets Interdependence and Financial Stress 9 Interdependence in Emerging Economies: The Case of Equity Markets 133 9.1 Introduction 133 9.2 The multivariate VAR-EGARCH model 134 9.2.1 The mean equation 134 9.2.2 The variance equation 134 9.2.3 Covariance relationship 135 9.2.4 Summary of the relationships 135 9.3 Data and descriptive statistics 136 9.4 Results: conditional mean results 136 9.4.1 Asymmetrie transmission based on the conditional variance 138 9.4.2 How vulnerable is South Africa's economic growth to an unexpected positive stock price returns and volatility shocks? 139 9.4.3 Are there any differential effects between stock returns and volatility on economic growth? 141 9.4.4 To what extent do stock price dynamics differ from other shocks? 142 9.4.5 Do stock price returns and volatility transmit portfolio outflow shocks into the economy? 144
x Contents 9.5 Which shock between stock price volatility and monetary policy tightening impacts economic growth the most? 145 9.5.1 How would economic growth have evolved in the absence of stock returns and volatility? 146 9.6 Conclusion 148 Appendix A9 148 10 Financial Stress, Volatility and Economic Activity in South Africa 150 10.1 Introduction 150 10.2 The construction of the financial stress index 151 10.3 Data and the construction of the FSI for South Africa 154 10.4 The FSI and its effects on economic activity 155 10.4.1 The relationship between financial stress and economic activity 155 10.4.2 Impulse response analysis 156 10.4.3 The propagation role of the financial stress index 156 10.4.4 Effects of financial stresses on monetary policy reaction function 157 10.5 Conclusion 159 Appendix A10 160 11 Conclusion 161 Notes 167 References 171 Index 183