Domestic Debt Creditors and Economic Growth in Zambia and South Africa

Makoto R, Mumvuma T and Kadenge GP

Published on: 2022-08-01


The study investigated the growth implications of domestic debt borrowing in developing countries where domestic debt markets are characterized by a thin investor base. In such markets, excessive domestic borrowing might retard growth through the crowding out of private investments, while recourse to central bank borrowing tends to be inflationary. The study tested these hypotheses using a Markov regime-switching model and found that seigniorage revenue has a positive and greater effect on growth in South Africa than in Zambia, while non-bank holder has a positive effect in the case of South Africa and negative for Zambia.   A negative effect of borrowing from commercial banks was only confirmed for Zambia. We recommend that countries that resort to seigniorage revenue should ensure that the resources are productively utilized and the recommendation is in line with the modern theory of deficit finance.


Domestic Debt Creditors; Seigniorage Revenue; Non-Bank Holders; Economic Growth


In the post HIPC period, two major innovations in sovereign debt were observed; debt switching towards domestic debt accumulation in traditionally external debt dependent countries and deepening of domestic debt investor base.  For instance in SADC, domestic debt rise by over 20% of GDP in the post HIPC period 2005- 2013, and in Zambia, one of the country that benefited from the HIPC programme, it was 68.2% of total public debt in 2006. In comparison South Africa which is one of the regional countries that issues more of domestic debt experiences dramatic shifts in the composition of domestic investor base recording a rise in foreign participation in domestic debt markets. Debates on the real effects of creditor classification in such emerging economies have escalated, with both theoretical and empirical literature providing different arguments and predictions. Domestic debt can be issued to monetary authorities, depository banks or the public. Most economists are skeptical about the issuance of too much debt to monetary authorities. The financing strategy usually tends to be inflationary and therefore can inhibit economic growth (Sargent and Wallace, 1981). The so called inflation tax has dominated empirical research in most developing countries. The study test whether seiniorage revenue is detrimental to growth or stimulates growth in line with claims of the modern theory of deficit finance (Armstrong, 2019) and functional finance hypothesis (Lerner, 1948). The latter claim that the detrimental effects of seiniorage revenue on growth are minimized if domestic debt is put on productive spending. Countries can finance growth using seiniorage revenue if they possess tradable resource endowments. In comparison, bond finance can have two possible outcomes on economic growth depending on the consumption behaviour of household or firms. Domestic debt issuance to the banking system may crowd out output through multiple channels (Chrystal and Thornton, 1988; Gaber, 2010).  Borrowing from depository banking institutions may accelerates the crowding-out effect and increases balance sheet exposures to fiscal developments. Countries can therefore be exposed to a component of domestic debt burden, some countries face debt monetization problem or may be exposed to the banking system. A well-diversified investor base that includes non-bank institutions such as pension funds dampen risk and volatility of interest rates which is necessary for growth. In recent years other countries has shown preference on pension funds as holders of long term domestic debt.

Conclusion and Policy Recommendation

In this study the effects of domestic debt on growth were investigated in South Africa and Zambia.  The results showed that the impact of domestic debt composition on debt varied across different domestic debt creditors and the effects were regime based.  In contrast to previous studies, the study found seiniorage revenue to stimulate growth in South Africa and Zambia.  The impact was greater in SA than Zambia; South Africa has a well-diversified domestic debt market and high bond demand than the later. However, these countries rarely issue debt to the Central Bank.  A positive effect of non-bank holders on growth was confirmed for South Africa and negative in the case of Zambia. A negative effect of borrowing from commercial banks was only confirmed for Zambia. Quantity effects could provide a plausible explanation; Non-bank holder had a greater effect in South Africa as most debt was issued to these creditors whilst commercial bank holder had greater impact in the case of Zambia where the domestic debt composition was biased towards commercial banks. The effects vary with time and quantities and the structure of government bond demand.  Therefore understanding the topology of debt composition matters for growth. The study recommend for financial development policy that encourage greater participation of non-bank holders such as pension funds. Although the study managed to address the real effects of domestic creditors, the recent rise in foreign participation in domestic debt is an interesting researchable gap. 


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