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

Abstract

The objective of this study was to investigate the relationship between real exchange rate and economic growth in South Africa. Using time series data, the period from 1980 to 2015 was covered in the study. Data was collected from the South African Reserve Bank, the International Monetary Fund and International Financial Statistics. The Johansen cointegration and the Vector Error Correction Model estimation techniques were employed in the study, followed by VEC Granger causality test, variance decomposition and impulse response function. The long-run results revealed a negative and significant relationship between real exchange rate with export and economic growth. On the other hand, money supply and foreign direct investment have a positive and significant relationship with real exchange rate. Only export was significant and positively related to real exchange rate in the short-run. Results of granger causality showed that only export granger causes real exchange rate thus, a unidirectional causality exists between export and real exchange rate. Results of variance decomposition revealed that the real exchange rate is highly affected by shocks from economic growth. The impulse response functions showed that real exchange rate responds positively to shocks from real exchange rate and money supply. On the contrary, real exchange rate responds negatively to a shock from economic growth. There is, therefore, a need to increase exports, money supply, foreign direct investment and economic growth as these would lead to an increase in the Rand and consequently, appreciation of the Rand.

Impact of an Undervalued Exchange Rate on Economic Growth

“… the combination of significant international reserves and insignificant foreign savings warns the economy against the destructive impact of external shocks, preventing exchange rate volatility and thus contributing to economic growth;  national currency devaluation increases tradable industries' profitability, especially labour-intensive ones, and their production volumes; hence it promotes weaker foreign exchange restrictions, capital accumulation, the spread of technology and learning externalities, thus contributing to economic growth. Source: author's summary based on [1,3,4,5,6] Research results. Most scientific studies empirically confirm the connection between the exchange rate and economic growth.…”

“…However, some studies demonstrate a weak, absent, inverse, or negative relationship between variables. The case of the Republic of South Africa during 1980-2015 proved that the exchange rate does not affect economic growth but depends on its shocks, causing Rwanda to strengthen [4]. In Kazakhstan, during 2009-2019, a fall in the real exchange rate by 1% led to an increase in GDP of only 0.004-0.005 pp.…”

“…Among other scientists who have studied theoretical depreciation's impact on economic growth, summarized in table 1, one can note D. Patel and G. Mah [4], S. Mbaye [5], and Z. Ybrayev [6]. A comprehensive analysis of the possible influences and their pro et contra will allow one to form an optimal macroeconomic policy for Ukraine, considering the specifics of the national economy.…”