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

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.