Professor André C. Jordaan from the University of Pretoria held an academic talk on the topic of real exchange rate misalignment – the case of South Africa during the previous week at the North West University. In this presentation he discussed the importance of a real exchange rate which should be kept in equilibrium, the importance of a stable real exchange rate in South Africa and the difference between an undervalued and overvalued exchange rate and the problems related to it. In this blog a brief overview on this presentation will be given after which a conclusion will be formed on real exchange rate misalignment in South Africa.
A real exchange rate is important for enhancing economic growth in a country and since South Africa has a high trade propensity the real exchange rate of the country is even more important. An equilibrium or ideal exchange rate is when internal and external equilibrium prevails. But South Africa’s current account is running very big deficits and the country is importing a lot. High export numbers are expected as a result of the high prevailing exchange rate but still exports aren’t picking up (exports are SA’s main inflow of money).
It is thus clear that South Africa’s real exchange rate is misaligned. Misalignment is calculated by subtracting the actual rate from the equilibrium/ ideal rate. Misalignment can take place in the form of an overvalued (when prevailing exchange rate is higher than the ideal rate) or an undervalued (when prevailing exchange rate is lower than the ideal rate) exchange rate. An overvalued exchange rate is more problematic than an undervalued exchange rate since it has an impact on the competitiveness of a country’s international position.
South Africa’s real exchange rate has been volatile in the last decade and since 2003-2006 it has been overvalued. An overvalued exchange rate leads to less exports, harms the primary sector, more imports which in effect leads to more required reserves and pressure on the current account and thus a decrease in a country’s savings. Since all of these things has a negative effect on South Africa’s growth, intervention by the government can be used to return the real exchange rate to equilibrium (determined by Professor André C. Jordaan in an empirical study he did).
Unfortunately there has to be realistic approach to this theory on real exchange rate misalignment in South Africa. South Africa’s five biggest banks’ foreign deposit ratings as well as the government’s credit profile rating got dropped from A3 status to Baa1 status by the rating agency, Moody’s on 4 October 2012. http://www.fin24.com/Companies/Financial-Services/Moodys-downgrade-SAs-five-biggest-banks-20121004 Together with this the country is experiencing a lot of political unrest as a result of mine workers and truck drivers striking. Realistically one should say to oneself, this might spiral out and get even worse in the near future.
As far as a conclusion goes: as a result of these resent happenings South Africa’s real exchange rate theoretically should be fixed by means of government intervention but recent events made the issue surrounding the country’s real exchange rate very uncertain and unpredictable. So what will happen? My guess is as good as yours, and as they say: only time will tell.