The Impact of Exchange Rate Expectations and Interest Rate Differentials on Trade in South Africa: An Econometric Analysis

Abstract

This study analyses the impact of exchange rate expectations and interest rate differentials between South Africa and its major trading partners and its effects on trade balances and employment in the exporting sector employment, using quarterly South African data covering the period 1977 to 2008. An empirical model linking the real exchange rate and interest rate differential is instigated to its theoretical determinants is then specified. The study utilizes the VECM methodology to provide both the long run and short run dynamic effects on the trade balance movements. Variables under investigation, (TOT, REER, IR, and IRS) were found to be statistically significant with the trade balance. The VECM model found 3 cointegrating equations and the most interesting result that came from this analysis is the co-movements of real effective exchange rate and interest rates differentials among the 3 cointegrating equations.