Fiscal Consolidation, Fiscal Policy Transmission, and Current Account Dynamics in South Africa

The debate on global current account imbalances continues to develop, with growing interest in the macroeconomic instability and widening current account deficits faced by emerging markets. Literature establishes that the current account behaves differently depending on macroeconomic circumstances in countries, so approaches to managing external imbalances should be country tailored. Despite this realisation, there is a lack of investigation into drivers of the current account and the impact of macroeconomic policy on current account dynamics in emerging markets. To address this, the study estimates an SVAR model to analyse the effect of fiscal shocks on the current account. This helps to understand how fiscal shocks shape current account developments, and establishes the usefulness of fiscal consolidation in managing current account deficits by determining whether the twin deficits approach to managing the external balance holds in middle income countries. The study goes further to analyse the channels through which fiscal shocks are transmitted to the current account to understand how current account management policies should be formulated. The study contributes to the literature by providing a case study of South Africa, an emerging economy characterised by large current account deficits, macroeconomic volatility, a well developed financial sector, and a dataset which has not been exploited to understand the external balance. A particularly interesting finding is that expansionary fiscal shocks improve the current account through household savings and public investment , which is a departure from the twin deficits hypothesis.