Economic laws are iron clad. But its theories are full of exceptions. Like the one which argues that a lower exchange rate improves a country’s trade balance with the rest of the world. Indeed, the opposite is the rational consequence when a country’s exports can be substituted, but its imports not. Statistical economist John Maynard takes a close look at the stats which show how the weak rand correlates negatively with South Africa’s trade account – coming to the the irrefutable conclusion that a weak exchange rate hurts rather than helps this economy. Worse, he has quantified it. To the tune of a staggering R150bn in the last six years. As for those who argue the perverse theory that bad political leadership, a la Nenegate, is actually good for the economy – they’re wrong. Dead wrong. – Alec Hogg
By John Maynard*
There is a myth that a weaker exchange rate leads to greater exports and lower imports and therefore improved trade balances.
The economic theory is easy to understand: As the exchange rate of Country A weakens, goods imported get more expensive and those exported become cheaper for Country B to import. While the theory is sound and may apply to some countries, this is certainly not the case for South Africa.
The graphic below shows South Africa’s trade balance per month from the beginning of 2010. A surplus (green) shows when South Africa’s exports exceeded its imports A deficit (red) is when South Africa’s imports were higher than its exports.
The graphic also tracks the Rand/Dollar exchange rate (light blue)Â per month during the same period. The Dollar is used as a benchmark as most of the world’s trade takes place in this currency.
It is clear from the graphic below that a weaker exchange rate has not led to increases in South Africa’s trade balance. In fact the reverse is true. As South Africa’s exchange rate gets worse, the trade balance is getting worse too.
South Africa’s Trade Surplus/Deficit
Why does economic theory regarding a weakening exchange rate’s impact on trade balances not hold true for South Africa?
- Demand for South African exported goods – mostly commodities such as coal and platinum – is not completely inelastic. Demand has dropped off in recent years and combined with this there has been less capital inflows from foreigners into SA. In fact there has been large scale capital outflows in recent months, putting immense pressure on the exchange rate. Companies are no longer expanding or investing in South African businesses (in particular mining). Reasons include lacklustre returns earned on commodities over the last two years. Less investment in a country leads to less demand for that country’s currency and therefore a weaker exchange rate.
- Demand for imported goods are more inelastic than demand for the country’s exported goods. South African manufacturers/consumers still require and consume foreign-made goods (even though the Rand price of importing such items is rising, the demand is not falling due to increasing prices). Thus demand for imports is inelastic as it’s not affected much by price increases.
- Put differently, SA is exporting non-essential goods (other countries can survive without some of our larger exports like coal, iron ore, platinum), while the country cannot survive without the goods it imports. Think about this in terms of exporting platinum vs importing crude oil. At any given point a country can survive without importing platinum. But can South Africa survive by not importing crude oil from Nigeria, Angola, Saudi Arabia etc? Not likely.
Is government and the South African Reserve Bank (SARB) aware of this? Do they realise that economic theory hammered into economics and business students does not necessarily hold true for South Africa?
Should we not try set policies to ensure a stronger currency?
Making imports of essential items like crude oil cheaper via a stronger exchange rate could more than offset exports becoming more expensive, leading to a smaller deficit or even a positive trade balance.
We can’t really say if this will be the case as we need to know where South Africa’s equilibrium exchange rate is, and what impact having a 10% stronger or weaker than equilibrium exchange rate has on our trade balances and the economy in general.
What we do know is SA needs to address its trade deficit which since January 2010 to January 2016, has ballooned to just over R150 billion. That means in the last six years the country has spent R150 billion more on buying goods from the rest of the world, than what it receives from selling goods to the rest of the world.
That R150 billion amounts to basically two months in which SA imported goods and exported absolutely nothing. At the same time the Rand has depreciated from around R7.45 to the US dollar to over R16 a dollar by January 2016. Clearly a weaker exchange rate DOES NOT boost South African export earnings.
There is a 0.42* positive correlation between a weakening exchange rate and increasing trade deficit, and this when economic theory/hypothesis expects a strong negative correlation between the two variables. *Correlations are measured between -1 and1, with -1 being a very strong negative correlation and 1 being a very strong positive correlation. Correlation values close to 0 implies no correlation between two variables.
South African policy makers need to look at these kinds of issues in more detail and more proactively. In an ever evolving world, does economic theory and thoughts that were developed decades ago still hold true? If not, we better evolve and adjust our policies accordingly.
- John Maynard is the nom de plume of an independent economist who is obsessed with official statistics – and uses these facts to blast through misleading narrative and propaganda. For more of his unique insights click here.
