Heightened Foreign Economic Policy Uncertainty Shock Effects on the South African Economy: Transmission via Capital Flows, Credit Conditions and Business Confidence Channels

Abstract

We examine the extent to which foreign economic policy uncertainty shocks are transmitted via the capital inflows, credit conditions and business confidence channels to impact South African GDP growth. Evidence shows that heightened foreign economic policy uncertainties deter both debt and equity inflows into the domestic economy, lowers business confidence, tighten credit conditions. These effects reduce GDP growth. There is a presence of endogenous credit cycles or the financial accelerator mechanism in propagating the initial economic policy uncertainty shock. The tightening in credit conditions can result in higher external premiums for raising capital in financial markets. Furthermore, banking and non-banking flows decline in response to heightened foreign policy uncertainty shocks. Positive economic policy uncertainty shocks have asymmetric effects on equity inflows depending on the size of the shock. Evidence suggests that elevated foreign economic policy uncertainty deters equity and debt inflows into South Africa. Equity inflows amplify the tightening of credit conditions compared to debt inflows. Equity and debt inflows propagate the adverse effects of heightened economic policy uncertainty via tight credit conditions. The implication is that firms with poorer indicators of creditworthiness will be more constrained than those which are creditworthy, and this can negatively affect investment and growth.