Question

1.4 "the rand depreciated, on average, against the US dollar (from 13.90 to 14.90 rand per USD) during the period under review."

critically evaluate the possible impact of the depreciation of the Rand on the trade balance in South Africa.(10)

Answer 1

In the modern era, exchange rates are no longer fixed but currencies instead ‘float’ against one another like prices in a market. This does not mean that they completely free to fluctuate; central banks retain some influence over them via monetary policy and they are influenced to some extent by trade policy and exchange control. For this reason, government policy sometimes addresses the need to retain the exchange rate at a competitive level, i.e. to prevent it from appreciating to the extent that export sales are negatively impacted. On the other hand, depreciation could be encouraged or aided through relaxing monetary policy. South Africa’s own Industrial Policy Action Plan (IPAP) has in the past specified that a competitive level for the exchange rate is a key part of industrial policy and one that is necessary in the light of limited fiscal space (limited resources with which to directly support industries).

A depreciation in the exchange rate will not help competitiveness unless it is a ‘real’ depreciation – i.e. the currency must lose value at a greater rate than relative prices are rising domestically. This is another way of saying that the depreciation must not be offset by higher inflation in South Africa relative to our trading partners. Provided this condition holds – i.e. the rate of inflation in South Africa relative to that in our trading partners is not greater than the rate of depreciation – our goods will technically become more competitive in the markets of our trading partners.

Continued Rand devaluation runs the risk of entrenching SA as a country with a substantial export share but one which still remains poor (has a low GDP per capita and hence low living standards for its population) with a high unemployment rate.

By pursuing a weaker Rand, workers become trapped with ever lower wages, as their purchasing power continually diminishes (inflation rises relentlessly).

There is no real escape other than attempting to stem the tide of currency devaluation, which becomes harder to do the longer it is pursued.

As should have already been learnt in SA, Rand weakness results in higher import costs. The Rand’s weakness of the past two years demonstrates this as strike incidence has increased as workers agitate for higher wages to meet the higher cost of living.

Indeed, substantial, ongoing rand weakness makes the cost of importing goods, particularly machinery and other technology used in production, exorbitant or unaffordable.

This negatively impacts infrastructure expansion and so electricity tariffs will need to be pushed up even much more significantly than is already occurring (the cost of importing the capital equipment needed in new power stations rises as the Rand weakens).

The risk to foreign investment in SA that seeks higher interest rates is clearly not an increase in global interest rates but rather the risk that the rating agencies will downgrade SA’s bond to closer to speculative grade on ongoing strike action and the resultant reduction in GDP growth (and so widening of the budget deficit and debt ratios) and widening of the trade deficit.

Workers under substantial Rand depreciation are doomed to face producing relatively cheap products and earning low salaries as a result of substantial currency depreciations, without the ability to tap into economies of scale as the cost of mechanisation of the production process is beyond the country’s reach because of the severe weakness of the currency.

Unsurprisingly strike incidence increases.

Clearly, weakening the currency for the immediate gratification of a more competitive rand, i.e. one which temporarily increases the country’s level of exports, would actually result in a substantial lowering of living standards for those already employed.

A country’s standard of living is shaped by its output, the more it produces through the use of its resources, whether these are human, natural or capital, and the more efficient the production, the more there is to go around (including tax revenue) so long as the gains are not eroded by inflation.

High levels of quality health care, education and public services become easily affordable and per capita incomes keep rising significantly (sustainable employment growth results) in an environment of high growth and low inflation.

Furthermore, the manufacture of high quality, innovative products, which come with a high price tag and do not need currency deprecation to boost demand, allows a nation to support high wages, a strong currency and attractive returns to capital resulting in a sustainable, high standard of living.

Restructuring the economy to export low priced products will only support subsistence wages, and translates into a low level of GDP per capita, an outcome workers are already showing they will clearly not accept with the rise in strike action in the mining, agriculture, transport and other productive sectors such as the textile industry.

And substantial wage increases have caused retrenchments when companies find they cannot increase the price of their products to match the rise in labour costs.

A perceived need for Rand depreciation merely indicates a perceived lack of belief in a country’s potential competitiveness, i.e. the country has to compete on price instead of on quality to gain market share.

If the Rand is weakened substantially producers will prefer to sell agricultural products overseas (given the higher return) and workers will find food prices escalating sharply and so demand higher wages.

The resulting sharp increase in labour costs and electricity tariffs to compensate for higher wages demanded because of the higher cost of food, living expenses and capital equipment respectively will quickly erode any competitive benefit from the rand’s weakness.