Beware long-term rand weakness, warn economists
February 14, 2007
By Ethel Hazelhurst
Johannesburg - The benefits to exporters of a weakening rand are short term and attempts to depreciate the currency can be short sighted. This is the view of two economists who closely monitor factors that affect South Africa's international trade.
They are Lawrence Edwards, an associate professor at the University of Cape Town who has researched the relationship between changes in the value of the rand, inflation and export performance; and Philip Alves, an economist working with the Development through Trade programme of the SA Institute of International Affairs.
They were responding to suggestions this week by Mandisi Mpahlwa, the minister of trade and industry, that a weaker currency would aid growth. He cited research published by the Centre for International Development at Harvard, which said: "Fighting exchange rate appreciation is associated with higher growth in the economy."
But Alves and Edwards say a weaker exchange rate results in higher import prices, which soon push up producer costs, eroding the benefits of stronger rand revenue flows.
The short-term effect of a depreciation can be beneficial. "The greatest beneficiaries would be producers sitting on inventories," said Alves. "When the rand weakens, these can be sold on world markets immediately, as prices in foreign currency terms are lower.
"But South Africa is a small economy. More expensive imports will soon feed into domestic prices, pushing them up, especially imported inputs. So in real terms, the price advantage is soon eroded," said Alves.
While higher export revenue stimulates economic activity, it does not necessarily have an immediate impact on gross domestic product, which is measured in volume terms. According to Edwards, commodity producers have to invest to produce more, which introduces an element of risk and ensures only a lagged response.
"Non-commodity manufacturers are more responsive to exchange rate depreciation and will produce more for export. But eventually, as inflated input costs catch up, they find themselves in the same position they were in before the depreciation," said Edwards.
He said a real depreciation in the currency (the nominal exchange rate adjusted for inflation) could "increase exports … and reduce imports". But this would need additional policy instruments and Mpahlwa had given no indication of what these might be.
While the growth effect of the nominal depreciation is soon eliminated, the inflationary impact lingers. Ridle Markus, an economist at Absa, pointed out higher inflation would attract higher interest rates, which "will have the unwanted outcome of depressing fixed investment".
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