Local‐Currency Sovereign Risk on South African Government Bonds: The Role of Sovereign and Exchange Rate Risk as Drivers of Changes in Nominal Bond Yields

ABSTRACT

While local‐currency bond markets have become a dominant source of emerging‐market financing and an integral component of the global financial system, market‐observed measures of sovereign default risk are still based on foreign‐currency denominated debt. This paper assesses the Du–Schreger credit risk spread on local‐currency debt for South Africa for the period between January 2008 and October 2022, and shows that it is a good measure of local‐currency credit risk for South Africa, in that it reflects developments in domestic sovereign risk while being less responsive to external developments than measures based on foreign‐currency denominated debt. The credit spread is then used to examine the role of sovereign and exchange rate risk as drivers of changes in nominal bond yields. For the review period, global factors, particularly the US dollar, are shown to be significant drivers of changes in nominal yields relative to domestic factors, while sovereign risk became less significant over time.