The Investigation of the Long-Term Effects of Budget Deficit on the Economic Growth of South Africa : a Comparison between VARMA and VAR Models

Abstract

The study investigated the long-term economic effects of Budget deficit on the economic growth of South Africa. The study followed an econometric approach in which various tests including Johansen’s test of cointegration, VECM and Granger causality test based on VAR(p) as well as VARMA(p,q) models were employed. Forecasts and Impulse Response analysis were performed based on the VAR(p) model and the VARMA(p,q) model to compare the forecasting performance of both VAR(p) and VARMA(p,q) models. The study used quarterly time series data of 100 observations for the period of 1994:Q1 to 2018:Q4 obtained from the South African Reserve Bank (SARB) and Statistics South Africa (STATSSA). The principal series used in the study are GDP growth rate and Budget deficit as a percentage of GDP. The additional variables are fixed investments, total national debt, government expenditure, and exchange rate (per US dollar). The overall results of the study revealed that there is a negative causal and significant long-run relationship between Budget deficit, exchange rate (per US dollar) and GDP growth rate in South Africa. This conforms to the Neo-classical hypothesis that holds that Budget deficit is detrimental to the economy of a country. The results of the study also revealed that in the short-run, the economy of South Africa is characterised by Keynesian hypothesis as it provides compelling evidence that temporary Budget deficit occurring because of productive government spending will positively affect the economy of a country. Lastly, the results of the study showed that the South African economy will grow at a slower pace between 2020:Q1 to 2021:Q4 at about 1.3% average rate. Based on the results of the study, it is recommended that South African policy makers come up with credible plans and measures to reduce the Budget deficit by stabilising/reduce total national debt and improve tax revenue collection system. The results also show that the South African economy is dependent on government spending. Therefore, the South African government should consider modifying the sectoral distribution of the government spending and focus more on productive sectors rather than services sector.