Question

Discuss how an exchange rate is determined and what South Africa can do to ensure that a depreciating currency does not affect economic growth. In your answer, look at a number of factors, which include the volume traded, the general economic conditions at the time of trade, and, where applicable, government mandates. [50 marks)

Answer 1

Exchange Rate- Depending factors
A flexible exchange rate is determined by the market forces that is demand and supply. Since the rates fluctuate, demand and supply for the domestic currency and of the foreign one determines the rate at which both should be exchanged. In case of fixed exchange regime, central bank of the domestic country pegs the rate which the domestic currency should be exchanged with the foreign one.
A depreciating currency with floating exchange rate could help South Africa to attain economic growth without much effort. Depreciation makes imports expensive and export cheaper. Domestic exporters become more competitive increasing the growth of the economy influencing the trade balances. Depreciation should positively impact the export sector. If depreciation is high and the export growth is low, that can further leads to fall in economic growth. Also, the rate of inflation could be controlled affecting the price level in the market. Expensive imports may leads to cost push inflation and the raise in the performance of the export sector may lead to demand pull inflation. The effects in higher inflation and price level cannot be ignored in the future. So, government should be vigilant in keeping the demand for the domestic currency moreover constant. A higher fall in the value can lead to inflation and higher price level in the market. Growth in export and fall in imports can all help the country achieve economic growth with depreciating currency. This will impacts in the trade balances of the country too. Also, the need of a mild inflation will help the economy to grow with slightly depreciating domestic currency.