Threshold effects of public debt on economic growth in South Africa: an application of a regression kink with an unknown threshold

Abstract

PurposeSouth African public debt has recently increased significantly and has reached worrying levels. This study aims to examine the debt threshold effects on economic growth in South Africa, with an objective of suggesting a debt threshold as South African policymakers will seek to reduce debt to a sustainable level in the coming years.Design/methodology/approachThe study applies a recent novel methodology advanced by Hansen (2017) that allows modelling a regression kink with an unknown threshold.FindingsThe findings of this study indicate a robust debt threshold of 37% of gross domestic product (GDP). Below this threshold, debt is growth-enhancing, but above 37% of GDP, debt is harmful to growth in South Africa.Practical implicationsAmong other things, to reduce the debt-to-GDP ratio, South Africa will need a fiscal consolidation policy by undertaking reforms to state-owned companies to reduce their reliance on public funds, as well as putting in place economic measures to boost long-term growth. The country should also improve tax collection in order to realize additional tax revenue through enhancing compliance and other revenue collection measures.Originality/valueMost of the existing studies on debt threshold effects in Africa are panel data studies, which assume parameter homogeneity, by determining a single debt threshold value applicable to all countries. This can be misleading as the debt-growth nexus is country-specific, being conditional on several factors, such as institutional quality. The present study applies a recent novel methodology, which allows to model a regression kink with an unknown threshold, for the case of South Africa. The methodology endogenously determines the debt threshold while also allowing a country-specific analysis.