An evaluation of the relationship between government bond yields, exchange rates and other monetary variables : the South African case

Abstract

Over the past few decades, governments have increasingly used bonds to acquire revenue to finance development and infrastructure projects. Several internal and even external factors influence the bond price as well as the bond yield rate. Developing countries use government bonds to finance developmental projects, but their bond yield rates are relatively high compared to developed countries, resulting in high levels of debt repayments. This study has the primary aim to analyse the relationship between the government bond yield and several macro-economic variables, including the exchange rate, repurchase rate, inflation and government debt. The study used South Africa as a proxy for developing countries. A quantitative methodology was used through the estimation of an econometric model using monthly time series data from 1994 to 2020. Government bond yield was selected as the dependent variable with independent variables including the exchange rate, the repo rate, inflation and government debt. Both long- and short-run relationships were found between the variables using the Johansen co-integration and vector error correction model (VECM) methods. These long-run results are important as they indicate that a depreciating exchange rate, rising interest rates and inflation, as well as rising debt levels, lead to increasing bond yields, which lead to increasing debt repayments. In conclusion, the results of the study indicated that a stable macro-economic environment is required for economic growth, while volatile exchange rates and yields do negatively affect growth; rising inflation does lead to rising repo rates, depreciating exchange rates; inflation should be contained within the inflation targets; and lastly, policy certainty is important to keep rates and yields stable, which could lead to investor confidence.