I wanted to start my throwing around of ideas about the South African economy with a simpler story of the drivers for growth, but this week the depreciation of the exchange rate and repo rate increase by the Reserve Bank makes for the big news.
One of the stories is that the weak rand will help to boost exports. Mike Schussler ripped into this idea earlier but also talked about a lot of the other challenges facing the SA economy. Depreciation of the rand cannot be seen as a growth strategy.
To add some academic perspective I wrote a post on the School blog drawing on a paper by Lawrence Edwards and Robert Garlic. The heart of the story is the following:
At an aggregate level there is a positive association between exchange rate depreciations and export performance. Edwards and Garlic lists the results from a range of studies and show that “a one percent rand depreciation is estimated to raise long-run manufacturing exports by 0.78 to 1.38 percent”. But this aggregate relationship fails to capture changes in competitiveness at the sectoral level. Their evidence shows that primary products are less responsive to exchange rate shocks than manufactured products. Non-gold merchandise exports (including manufacturing) are less responsive to exchange rate shocks than manufacturing alone. There are also differences across manufacturing sectors: the export response in natural resource-based and machinery & metal products sectors is generally lower than in labour intensive, chemical-intensive beneficiated sectors. And what about the channels through which the exchange rate affects exports? The evidence shows that South African exporters of manufactured goods are price takers in the international market. That means that export growth is not constrained by inelastic foreign demand or an inability to price competitively in the international market. This sound like promising news the minister would like to hear, but as always there are caveats:
- The extent of an export boom depends on the composition of exports. Historical evidence showed that manufactured exports are likely to benefit more than commodity exports, but looking at the nature of South Africa’s top-20 exports (from Edwards & Alves in SAJE, 2006) one sees that manufactured exports make up a small part of the mix.
- The length of an export boom depends on competitiveness, specifically on the cost of imported inputs and labour. The evidence shows that nominal depreciations have not sustained the profitability of exports. Domestic producer prices are very responsive to changes in the exchange rate – a 1 percent rise in import prices has raised domestic producer prices by between 0.85 and 1 percent in the long run.
Even if exporters are winners for a while, the South African consumer is a clear loser when the rand depreciates. Yesterday Neil Rankin tweeted a link to a paper that he wrote with Aron, Creamer and Muellbauer on the exchange rate pass-through to consumer prices. They found that:
overall pass-through to the almost 63 per cent of the CPI covered is about 30 per cent after two years, and higher for food.
Finally, I found this nice tweet on research about the use of interest rates to defend a currency. It is in the context of fixed exchange rates and in the South African case we are not really defending the rand, but rather the current account and fighting inflation expectations, but it still offers an interesting take-away: higher interest rates helps a bit, but only for a while.