Journal of Economics and Behavioral Studies (ISSN: 2220-6140) Vol. 10, No. 6, pp. 211-221, December 2018 211 Political Institutions and Macroeconomic Factors as Determinants of Credit Risk in South Africa S. Zhou, D.D Tewari Department of Economics, University of Zululand, Kwadlangezwa, South Africa sheuedu@gmail.com, TewariD@unizulu.ac.za Abstract: This study analyses the effects of political institutions and macroeconomic factors on credit risk in South Africa using quarterly data between 1998 and 2016. The study uses the ARDL approach to cointegration and reports on both long-run and short-run influences of credit risk. In the long-run political institutions and gold prices are found to positively impact credit risk whereas Gross domestic product has a negative influence on credit risk. In the short-run however political institutions have a negative influence on credit risk. Further, the study confirms the recent country risk downgrades by rating agencies, S & P, Moody and Fitch. Policies that grow the economy and are consistent with the government’s long-term strategy needs to be followed to improve investor and lender confidence. Keywords: Credit risk, political risk, credit rating, cointegration 1. Introduction Credit risk has become an important issue in today’s economies as it determines the flow of funds to meet production needs. With a huge reliance on bank credit, South African firms could find it difficult to compete at the global or regional level if the cost of debt spirals. On the other hand, the government of South Africa has been reeling under a huge stock of debt, increasingly growing as the country continues to face unprecedented trade deficits (Ayadi and Ayadi, 2008). The credit risk downgrades experienced recently 1 need to be analyzed in the context of the long-term relationship between political institutions and credit risk in the country. We ask the question whether political institutions matter for credit risk management in South Africa over both the short and long term. By so doing we contribute to the already established literature on the determinants of credit risk and proffer some policy options for the South African government. In debt markets, credit rating agencies play an important role by reducing search costs, lowering the incidence of moral hazard (Chang et al., 2017). During the past two decades rating agencies have become more popular, seemingly pointing out the bad apples from investment grade debt instruments. The South African government has not been spared by these referees, with several downgrades being assigned to the debt-burdened country as a result of several inconsistent decisions by the South African government. However, the long-term effects of such institutional factors on credit risk have not been documented. In this study we sought to establish to what extent these institutional factors are important in determining credit risk. Our results also seek to refute or validate recent public outcries over rating downgrades by credit rating agencies, Fitch, S&P and Moody’s. 2. Literature Review Credit risk is a measure of the probability of default on the principal and interest components of a debt instrument (Garr, 2013). This can arise due to the decline in the creditworthiness of the borrower or the inability on their part to fulfil their contractual obligations (Manab et al., 2015). Lenders are concerned with the level of credit risk because it determines the extent to which they will be able to receive returns on their investment. According to Manab et al. (2015) high credit risk ratings reduces investor confidence and can lead to divestment. Whilst a huge pool of literature exists on the relationship between credit risk and its associated bank-specific and macroeconomic determinants, the impact of institutional variables on financial stability cannot be dismissed (Ashraf, 2017, Roe and Siegel, 2011). Theoretically our study is founded on theories of bank risk-taking behavior and the theory of political institutions. Ashraf (2017) provides a theoretical link between bank risk-taking and political institutions in which political stability encourages high risk-taking by banks, and hence increases financial instability. According to Acemoglu and Robinson (2010) institutions can be divided into political and economic institutions. Whilst the former is equally important for the attainment of increased welfare, the latter is argued to be directly related to economic activity. Economic 1 South Africa experienced several credit rating downgrades during the period 2012 to 2017, during the Presidency of Jacob Zuma. brought to you by CORE View metadata, citation and similar papers at core.ac.uk provided by AMH International (E-Journals)