Reducing Debt Costs to Support Growth and Investment in South Africa: The Currency Premium and Local Currency Denominated Debt

In this paper we aim at identifying the determinants of South African currency premia in order to assess the scope of South African economic policies to narrow the spread on local-currency denominated debt. South Africa is one among very few emerging economies able to borrow long-term abroad in its own currency and one of the few that has developed its domestic bond market fairly well. However, allowing for the heightened and increasing instability in the nominal exchange rate of the rand over the last years, this fortunate specificity may fade away: local-currency denominated issues might become more expensive and less liquid overtime. Therefore, a key policy issue is how South African monetary policy may influence exchange rate determination and how it can be instrumental in stabilising expectations about the course of the rand, thus bringing down local-currency denominated debt costs. Moreover, lower debt costs are of utmost importance in boosting investment and future output growth. Using high frequency data and resorting to volatility modelling, we carry out an empirical analysis of the determinants of the 1-month and 1-year currency premia. Among these determinants, the South African Reserve Bank's Net Open Forward Book and the misalignment of the real effective exchange rate stand out. We also control for global risk aversion, the dollar price of gold, idiosyncratic and regional political shocks as well as other shifts in monetary policy, like the inflation targeting regime set up in early 2000.