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January – June 2018

Bond markets – the key to unlocking South Africa’s economic growth

  • Dr Ashenafi Beyene Fanta and Prof Daniel Makina
  • MAY 2018
  • Tags Insights, Finance
11 minutes to read


Article written by Dr Ashenafi Beyene Fanta and Prof Daniel Makina

Many researchers disagree on the direction of cause and effect between finance and growth, but a positive link does exist. Most examinations of the finance-growth link center around banks and stock markets, ignoring the role of non-bank financial institutions and the bond market.

While most theories predict unidirectional influence whereby finance leads to economic growth, some show that finance and growth have a bidirectional fundamental relationship. It is argued that when innovation increases, so does the demand for financial services – which in turn leads to growth in the intermediary sector. Others propose that growth enhances financial development by raising borrowers’ ability to secure a loan by using collateral net worth, and that finance promotes growth by increasing return on investment and, as a result, the rate of economic growth.

Most examinations of the finance-growth link … ignore the role of non-bank financial institutions and the bond market.

Role of intermediaries

The lack of well-developed financial intermediaries would be a particularly serious disadvantage for any economy.

Financial intermediaries – i.e. institutions such as banks, building societies and unit-trust companies that hold funds of lenders in order to make loans to borrowers – have the ability to monitor investment projects at a lower cost, which eventually increases entrepreneurs’ access to funds. In the absence of such intermediaries, monitoring costs would be too large, discouraging credit to entrepreneurs.

Intermediaries contribute to economic growth by managing the moral hazard problem (a situation in which one party gets involved in a risky event knowing that it is protected against the risk and that the other party will incur the cost) by designing incentive-compatible loan contracts to avoid diversion of funds towards other purposes.

Economic growth is expedited where intermediaries attract deposits from a large number of depositors out of which they create loans that can be used to finance long-term investment projects to promote capital formation.

South Africa is fertile ground for economic growth

South Africa has a well-developed and sophisticated banking sector comparable to those in some developed countries. A recent 2013 report by the World Economic Forum ranks South African financial sector development 28th in the world and first in Africa. The country’s financial sector is the second best in the BRICS economies, preceded only by China; and, in terms of stability, it is deemed to be one of the most stable in the developed world, ranked third in terms of financial market sophistication, preceded only by the UK and Switzerland.

The country has the largest stock market in Africa with a market capitalisation of 145% to GDP and was ranked first out of 142 economies for its effective regulation of securities exchange in 2012. With 19% market capitalisation to GDP ratio in 2011, the South African bond market is one of the biggest in emerging economies.

Having a turnover of 9% of the global bond market turnover, the country’s secondary bond market was ranked third in the world in 2011. Similarly, the country’s private credit by deposit money banks to GDP ratio of 142% in 2011 ranked first among emerging economies and was by far larger than that of China (121%), Brazil (63%) and India (47%).

Non-bank financial institutions constitute a large portion of the financial sector with total assets to GDP ratio being 95% in 2011 compared to only 78% for deposit money banks. These are financial institutions that do not accept transferable deposits but that perform financial intermediation by accepting other types of deposits or by issuing securities or other liabilities that are close substitutes for deposits as a share of GDP. This covers institutions such as savings and mortgage loan institutions, post-office savings, building and loan associations, finance companies that accept deposits or deposit substitutes, development banks and offshore banking institutions.

Although emerging markets have not had well-developed bond markets in the past, this has changed and bond markets now constitute more than 50% of the GDP in some of them.

Despite its robust financial development, South Africa is dragging its feet in terms of economic growth. During the period 1991 to 2011 growth per capita (GDP) in South Africa was lower at 5% compared to its BRICS peers Brazil (8%), India (7%) and China (15%) and only slightly better than Russia.

Financial intermediaries … such as banks … have the ability to monitor investment projects at a lower cost, which eventually increases entrepreneurs’ access to funds.

The role of bonds in economic growth

In a study considering three elements of a financial system – bond market, bank and non-bank financial institutions, and stock market development – it was found that bond markets have a significant effect on growth and are not driven by economic growth but are rather causing it.

Bond market development is found to have a negative effect on private credit issued by banks and non-financial institutions, implying interchangeableness between the two. This is due to the development of bond markets which might have slowed the growth of banks.

These findings are consistent with other research that reported markets substitute banks in sub-Saharan African countries such as Kenya, while the two complement each other in countries such as the USA. The same relationship is observed between institutional credit and stock markets, implying that market development may have slowed the development of institutions in South Africa.

In a study … it was found that bond markets have a significant effect on growth and are not driven by economic growth but are rather causing it.

It is found that there is a causal relation running from bond markets to growth, but not vice versa, and no causal relationship between either institutional debt and growth, or between stock markets and growth. In addition, economic growth is found to have no effect on the development of bank and non-bank financial institutions and stock markets.

This observation that the bond market – rather than the stock market, banks and non-bank institutions – promotes economic growth in South Africa prompts an intriguing question as to what unique roles bond markets play that intermediaries and equity markets are unable to play. An understanding of the channels through which the bond market contributes to economic growth in South Africa would be fertile ground for future research.

  • Original article: Fanta, A.B. & Makina, D. 2017. Equity, Bonds, Institutional Debt and Economic Growth: Evidence from South Africa. South African Journal of Economics, 85(1), 86-97.
  • Link to article:

Dr Ashenafi Beyene Fanta is a Senior Lecturer of Development Finance at the University of Stellenbosch Business School. He is also head of USB’s PhD in Development Finance. His research interests include financial markets and institutions, financial development, SME financing and financial inclusion.

Prof Daniel Makina is a Professor of Finance and Banking at the University of South Africa, with a special interest in policy and academic research in emerging financial markets, migration, international business, finance and banking.

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