South Africa considers the exchange rate as a key macroeconomic policy instrument in relation to ensuring export promotion and economic growth.
By Rachel Mlosy
For the past twenty years, many voices have demanded that we leave no one behind, ensuring equity, non-discrimination, inclusion at all levels and pay special attention to the people most in need. This is the country of South Africans.
Public discourse has underscored the call for the urgent need to recognise and address the volatility of the Rand. All inputs have emphasised the need to integrate economic, social and financial dimensions across the new agenda. To make this happen, they want norm- based policy coherence at all levels and to ensure that no harm is done to the country. These, they tell us, should be based on the solidarity, cooperation, mutual accountability and participation of government and all stakeholders.
Implementation of any system is not just about quality. It is also about doing things together, uniting around the problem. Sustainable development provides a platform for aligning private action and public policies. Therefore, all public funds must positively impact on the poorest and most vulnerable in all societies.
South Africa has witnessed the consistent depreciation of her exchange rate, the lowest levels being in December 2001 and December 2015. The Rand was established as the official South African currency on 14 February 1961 – and has since developed into a liquid emerging market currency, most commonly traded against the US dollar. In June 1974 the South African authorities decided to delink the Rand from the dollar, and introduced a policy of a managed floating exchange rate. The South African Rand was worth US$1.40 from the time of its inception in 1961 until 1982, when mounting political pressure combined with sanctions placed against apartheid South Africa started to erode its value. By February 1985, it was trading at over R 2 per dollar, and, in July that year, all foreign exchange trading was suspended for 3 days to try to stop the devaluation. The current flexible exchange rate regime has led to greater volatility of the Rand against the major currencies and such variability has implications for South Africa’s exports. At the time of writing the Rand was trading at 16.725 to the dollar.
Exchange rates across the world have fluctuated widely particularly after the collapse of the Bretton Woods system of fixed exchange rates. Since then, there has been extensive debate about the impact of exchange rate volatility analysis. Volatility refers to the amount of uncertainty or risk relating to changes in a security’s value. A higher volatility means that a security’s value can potentially be spread out over a larger range of values. The most commonly held belief is that greater exchange rate volatility generates uncertainty, thereby increasing the level of riskiness of trading activity and this will eventually depress trade.
The vast majority of economic literature on volatility analysis, however, contains highly ambiguous and inconsistent theoretical and empirical results. An increase in exchange rate volatility accompanied by sufficiently risk averse agents will lead to an increase in trade, because the increase in volatility leads to a rise in expected marginal utility of revenue from exports and an insignificant relationship exists between exchange rate volatility and trade. Sometimes policy-makers advocate less expensive currency in order to boost the export sector. They should be aware whether such a policy might depress the stock market and the link between the two markets may be used to predict the path of the exchange rate.
The proportion of foreign exchange transactions stemming from cross border-trading of financial assets has dwarfed the extent of currency transactions generated from trading in goods, services and employment opportunities.
The Rand Exchange Rate in the Economy
Keynesian economists often argue that private sector decisions sometimes lead to inefficient macroeconomic outcomes which require active policy responses by the public sector, in particular, monetary policy actions by the Reserve Bank of South Africa and fiscal policy actions by the government, in order to stabilise output over the business cycle. Keynesian economics advocates a mixed economy – predominantly private sector, but with a role for government intervention during recessions. Keynesian economics served as the standard economic model in the developed nations during the latter part of the Great Depression, World War II, and the post-war economic expansion (1945-1973), though it lost some influence following the oil shock and resulting stagflation of the 1970s. The advent of the financial crisis of 2007-08 caused a resurgence of Keynesian approaches.
The Post Keynesian group repeatedly distinguishes itself from the current mainstream by proposing various forms of capital controls and fixed exchange rate policies. It is argued that currency volatility, particularly that caused by speculators, is disruptive to the real economy; this leads to proposals for a fixed but adjustable exchange rate system.
South Africa considers the exchange rate as a key macroeconomic policy instrument in relation to ensuring export promotion and economic growth. The South African Reserve Bank’s exchange policy aims at providing an environment that promotes exchange rate stability and assists the government’s objective of accomplishing export-led growth.
Therefore, over the last two decades, South Africa has moved towards greater exchange-rate flexibility and deeper financial integration. At the same time, buffered by sizable reserve holdings, the county has also retained a fair degree of monetary autonomy, even as financial integration has continued. Modern infrastructure, increasing domestic demand and a competitive exchange rate are important factors in boosting a country’s manufacturing sector and trade. A special focus is required in order to achieve the target fixed for increasing the share of the manufacturing sector and trade in the country’s economic growth.
The Reserve Bank of South Africa’s policy of flexibility in the exchange rate coupled with the ability to intervene in foreign exchange markets is an important economic measure, taking into account that the primary purpose of the Bank is to achieve and maintain price stability in the interest of balanced and sustainable economic growth in the country. Together with other institutions, it also plays a pivotal role in ensuring financial stability and increasing Foreign Direct Investment (FDI) in critical sectors of the economy such as sustainable energy, infrastructure and transport, as well as information and communication technologies. The public sector needs to set a clear direction.
Exchange rates are determined in the foreign exchange market, which is open to a wide range of different types of buyers and sellers, where currency trading is continuous. Each country, through varying mechanisms, manages the value of its currency. As part of this function, it determines the exchange rate regime that will apply to its currency. For example, the currency may be free-floating, pegged or fixed, or a hybrid. If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change continuously as quoted on financial markets, mainly by banks, around the world.
The exchange rate is an important macroeconomic policy instrument that ensures economic growth. After the collapse of the fixed exchange rate regime in the 1970s among several countries, a number of research studies have been carried out to understand the sources of exchange rate fluctuations and its subsequent influence on inflation, investment, risk management, trade and welfare. For example, the 2001 September 11 attacks on the World Trade Centre in the USA caused the Rand to skyrocket to R13.84 to the dollar – year average of R8.60 – its worst level ever at the time – with a recovery period happening the following year.
South Africa can gain an advantage in international trade if the Rand keeps its value low.
The volatility of the exchange rate is essentially a measure of the fluctuations of the exchange rate (Abdalla 2011:217). It can be measured on an annual, monthly, weekly, daily or hourly basis. Provided that the changes in an exchange rate follow a normal distribution, the volatility gives an idea of how much the exchange rate can adjust within a certain period. Just as in the case for financial assets, the standard deviation is used to calculate the volatility of exchange rates.
In financial calculations two measures of volatility are used, namely the implied and historical volatility. Implied volatility is calculated using estimates of market participants of what outcome may most likely occur; therefore this approach is forward looking. Whereas historical volatility is calculated using past data of exchange rates. Using the historical approach we can utilise past daily data and from this obtain the standard deviations of the price changes and then the annual exchange rate volatility.
Just like the volatility of financial assets, the volatility of exchange rates changes in response to new information . As the level of uncertainty of an economy rises, the level of confidence in holding that currency for market traders falls. Traders are less willing to hold currencies that have a negative future prospect. Within the currency market, changes in the volatility can mainly be attributed to uncertainty about the future. Changes in the volatility of the exchange rate can also arise from an adjustment in the proportion of speculators and hedgers. Furthermore, an announcement from the central banks to intervene in the currency market can cause changes in the volatility.
The study revealed that the exchange rate variability has a positive impact on the competitiveness of agricultural exports from South Africa to the European Union.
The Impact of Exchange Rate Volatility on Trade and Employment
The increasing volume of trading of financial assets (stocks and bonds) has required a rethink of its impact on exchange rates. Economic variables such as economic growth, inflation and productivity are no longer the only drivers of currency movements. The proportion of foreign exchange transactions stemming from cross border-trading of financial assets has dwarfed the extent of currency transactions generated from trading in goods, services and employment opportunities. The asset market approach views currencies as asset prices traded in an efficient financial market. Consequently, currencies are increasingly demonstrating a strong correlation with other markets, particularly equities. South Africa can gain an advantage in international trade if the Rand keeps its value low.
A study done by Obi, Ndou and Peter (2012:229) on the impact of exchange volatility on the competitiveness of South Africa’s agricultural exports revealed some rather uncommon results. The study was on exchange rates of export volumes for sugar, apples, peaches, maize, grapes, utilising laspeyres- indexed export prices. This was done to assess the impact that exchange rate volatility had on agricultural exports to the European Union (EU) for the period of 1980 to 2008. The study revealed that the exchange rate variability has a positive impact on the competitiveness of agricultural exports from South Africa to the European Union.
If a government chooses a fixed exchange rate policy, and simultaneously attempts to achieve full employment, it could very well lose its foreign exchange reserves. Interest rates would rise as expressed by the forward price of the currency falling, while the spot price would be supported by a diminishing pool of foreign exchange reserves. This could happen with either a base programme, or a more traditional spending increase. Unemployment continues to pose significant challenges in South Africa: it reached 24.3% and youth unemployment 49% at the end of 2014 (Statistics SA 2014).
Adjustments in the levels of employment and unemployment are tied to changes in output through the production function (Hodge 2005:10). Generally, currency depreciation (appreciation) is related to employment increases (decreases) for both low and high pro t margin industry groups. Furthermore these conditions are aggravated as industries increase their export needs. In the case where a rm is heavily reliant on imported inputs, the positive effects of a currency decline can be reversed, leading to a zero net gain for the rm.
The sensitivity of employment and unemployment to the exchange rate is affected by labour regulations and market structure. In a market that is perfectly competitive, it is expected that any changes that have an impact on the price of a rm’soutputresultin changes of its returns. On the contrary, a rm is a price setter in an imperfect market. Therefore, the rm responds to a price increase by adjusting the mark-up as opposed to changing employment and output. A study by Goldberg and Tracy (1999) on the impact of changes of the exchange rate of the U.S. dollar concluded that local industries significantly differ in their hours worked, earnings and employment changes in response to changes to the exchange rate.
In a study on employment response to exchange rate movements for rms in Hungary, Koren (2004) found that the cost and demand effects were largely industry speci c. Koren went on to conclude that the overall effect of the exchange rate on the demand for labour was ambiguous (Hodge 2005:13). A study on the Turkish manufacturing sector by Filiztekein (2004) revealed how currency depreciation may in fact bring no gains for a rm. This is the case were a depreciation negatively impacts wages and employment. Cases where depreciation has a negative impact on wages and employment are the result of an industry being too reliant on imported intermediary goods. This is the case for the Turkish manufacturing industries. If an industry’s foreign inputs outweigh the positive effect of deprecation, depreciation in the currency will have a negative effect on wages and employment.
If an industry’s foreign inputs outweigh the positive effect of deprecation, depreciation in the currency will have a negative effect on wages and employment.
Economically weak and powerless South Africans feel the pinch the hardest. Poor people as a group suffer most from an ailing and inequitable national economic system. A decline in production and the disruption of trade create financial shortages, development programmes are the rst to be cut, and poverty, hunger and diseases are prolonged. The end of apartheid and the relatively peaceful transition to democracy, combined with the introduction of financial market liberalisation, led to large increases in the amount of capital in flows into South Africa. One of the main concerns since the flexible exchange rate regime was introduced has been the extent to which the increase in exchange rate volatility has impacted on trade and employment.
One of the main concerns since the exible exchange rate regime was introduced has been the extent to which the increase in exchange rate volatility has impacted on trade and employment.
A broad and comprehensive analysis between real exchange rate volatility and trade shows that there are theoretical models that postulate both positive and negative effects of the exchange rate volatility on trade and employment opportunities. However, earlier empirical evidence, using different measures of exchange rate volatility, usually fail to establish a statistically signi cant relationship between exchange rate variability and volume of trade. Where such a relationship is established, the coef cient of exchange rate volatility is either negative or positive.
Therefore from the policy perspective, South Africa needs to maintain a competitive exchange rate in order to sustain its export performance and create decent employment opportunities. As a country we cannot ignore the real exchange rate variability of the Rand in relation to policies that aim at enhancing its export performance and overall macroeconomic stability. South African policymakers should enact intervention policies that aim at reducing excessive variability of the real exchange rate of the Rand in order to improve its export sector, economic growth and overall external macroeconomic stability. This should be done to create decent employment opportunities in the rural and urban areas for men, women, young people and people with disabilities. ■
This article originally appeared in The Thinker and has been republished with permission.