Investigating the Impacts of Real Exchange Rates on Economic Growth: A Case study of South Africa.

Abstract

This paper examines the impact of real exchange rates on economic growth in South Africa. The paper uses quarterly time series data for the period of 1994 to 2010. The Johansen cointegration and vector error correction model is used to determine the impact of real exchange on economic growth in South Africa. The explanatory variables in this paper are real exchange rates, real interest rates, money supply, trade openness and gross fixed capital formation. Results of the study reveals that real exchange rates have a dampening long run impact on economic growth in South Africa. From the regression results, it is noted that undervaluation of the currency significantly hampers growth in the long run, whilst it significantly enhances economic growth in the short run. As such, the policy of depreciating exchange rates to achieve higher growth rates is only effective in the short run and is not sustainable in the long run. Based on the findings of this study, the authors recommend that misalignment (overvaluation and undervaluation) of the currency should be avoided at all costs. In addition, the results of the study shows that interest rates also have a significant impact on growth and since interest rates have a bearing on the exchange rate, it is recommended that the current monetary policy of inflation targeting be maintained in South Africa.

Relationship between Real Exchange Rate and Economic Growth: the case of South Africa

“…If the response of LNEXPO to LNRER is positive than negative, it is an indication that a shock to LNRER will cause LNEXPO to increase than decrease. These results are different from those obtained by Sibanda (2012), who found that all variables are significant even though they are not tenacious. Since REER shock encourages growth, however, from 8 quarters, it has a negative impact.…”

“…This is an indication that LNGDPD is the highest variable in explaining variations in LNRER for the South African economy. On the contrary, Sibanda (2012) revealed that EG describes most of its variations along with real interest rates while exchange rate does not explain much variation in economic growth. Figure 4 shows the response of LNRER to LNRER at an increasing positive effect to a decreasing positive effect on itself.…”

“…However, depreciation of a country's currency can only improve its trade balance and economic growth in the long-run when the Marshall-Lerner condition is satisfied. Thus, the traditional approach entails that real exchange rate enhances economic growth, implying a positive relationship (Sibanda, 2012).…”

“…Once the existences of cointegrating relationships are determined, VECM could be applied. This is done by the vector auto regression (VAR) of order P (Sibanda, 2012):…”

Real exchange rate undervaluation and sectoral growth in South Africa

“…Country specific studies for South Africa are very scant. Among them is a study by Sibanda et al (2013) which applies the Johansen and Julius test for cointegration and the vector error correction model on data observed at quarterly intervals from 1990:01 to 2010:04 and reveal a negative effect of misalignment on economic growth. Zwedala (2013) on the other hand uses the behavioural equilibrium approach to measure RER misalignment and the vector error correction model to establish its growth effects.…”