Emerging economies are known for their sensitivity of exchange rate volatility. Exchange rate volatility impacts economic growth in a large manner. When the real exchange rate is under- or over valuated, it impacts a country’s economic performance directly.
For a country, such as South Africa to enhance its economic growth, the real exchange rate should be at equilibrium. When the county’s real exchange rate is misaligned, it can lead to economic instability as well as less investments in the country. Misalignment can be explained as how the actual exchange rate deviates from the ideal exchange rate. Internal exchange rate balance is where there is full employment and full capacity of output in the economy. The external exchange rate balance is where there is a sustainable current account position present in the economy.
Exchange rate overvaluation is known for having much more problematic results. When the exchange rate is overvalued, undermines exports as it is now cheaper to import. The agricultural market is heavily influenced in such a case as the South African agricultural market doesn’t get that much support from government. Over valuation of the real exchange rate stimulates imports. This will cause an additional demand for foreign exchange and put pressure on reserves and increase borrowing requirements.
During the last 21 years South Africa experienced approximately 10 years of an overvalued exchange rate. It is evident from different studies done that an overvalued exchange rate is more damaging for a country than an undervalued exchange rate. South Africa can act in response to the overvalued exchange rate by stimulating exports and investments, move away from current consumer driven approach and put more focus on an investment and production approach.
Lezaan van Zyl