Examining the Twin Deficit Hypothesis: evidence from selected SADC countries (1980-2011)

Abstract

The dissertation investigates the existence of a causal relationship between fiscal balance and current account balance over the period 1980-2011, for nine SADC countries individually. The analysis is conducted within the framework of Granger causality test and Vector Auto Regression (VAR) approach on time series data for each individual country estimates. The Granger causality test results confirm the twin-deficit relationship, with a causal relation from fiscal deficits to external deficits for two countries: Malawi and Zambia together with SADC group average; inverse link operating from external balance to fiscal balance for another two countries: Zimbabwe and Swaziland. Existence of bi-directional causality was confirmed for Botswana and Ricardian Equivalence Hypothesis was confirmed for Mozambique. Results for Angola, South Africa and Seychelles were ambiguous hence inconclusive. The results point to the existence of a direct causal link from fiscal deficit to external deficit. There are indications that fiscal tightening (budget cuts) tends to correct the current account deficit directly. There is need for government to develop new exports, primary products beneficiation (value addition), use of nanotechnology and nurturing new export industries as a long-term measure. In Zimbabwe and to some extent Swaziland the current account can be used to address the budget balance. Countries such as Malawi and Zambia, which have shown evidence of the twin deficit, imply that policymakers must consider fiscal consolidation. Fiscal consolidation has proved to be effective; however half-hearted fiscal adjustments are doomed to fail. The relationship between the two macroeconomic variables changes over time depending on the dynamics of the economy. Again, given the intricacies that are innate in mixed economies, it may not be possible to authenticate a tight and steady connection between the two deficits