ANALYSIS OF THE IMPACT OF EXCHANGE RATE VOLATILITY ON THE SOUTH AFRICAN GOVERNMENT BOND MARKET

Although government bond markets in Africa have been growing steadily, one of the factors inhibiting the growth of these markets is that only a few African economies have clear access to global financial markets. This factor has been worsened by the volatility of exchange rates of these countries, which could potentially affect bonds’ yields adversely. This paper empirically investigated the impact of exchange rate volatility on the South African bond market and the economy as a whole. A quantitative technique was utilised with a Johansen cointegration estimation technique to determine whether the variables were cointegrated and to determine the effect of exchange rate volatility on the bond market and the economy. GARCH was used to generate exchange rate volatility from rand/US dollar exchange rate series, which was then used with other variables in a VECM for the main estimation. Monthly datasets from January 2000 to December 2018 were analysed with variables such as exchange rate, bond yields, real GDP and CPI included. The results from the Johansen cointegration test indicated that the variables have a long-run relationship. Furthermore, results from the VECM estimation indicates that volatility with regard to the external value of interest payment on government bonds discourages investment in the South African bond market. Inflation and economic growth are also found to have positive and negative effects on bond yield, respectively. The overall results from the study suggest that exchange rate volatility is one of the factors limiting the potential of the economy’s bond market by discouraging foreign investment in the market. To this end, both the monetary and fiscal authorities in the country need to work together to formulate and implement policies that would reduce the volatility in the South African currency.