The real exchange rate of the rand and competitiveness of South Africa's trade

In the last 10 years since South Africa transformed into a democracy, the rand has seen an increase in volatility of its real exchange rate. These fluctuations in the rand’s real exchange rate have raised questions as to whether they signify significant misalignment of the currency and thereby undermine competitiveness of South Africa’s exports abroad. This is a pertinent question in the South African context because foreign trade has been critical to the growth of the economy. Efforts to address current high levels of unemployment and widespread poverty among the majority of the population have depended upon this growth. This study investigates the extent to which fluctuations in the rand’s real exchange rate have impacted on the competitiveness of South African trade flows by determining whether, at some point, the rand had been misaligned, and the likely consequences of such a misalignment. Using data from 1972 to 2003, and an equilibrium correction model of the rand’s real exchange rate drawn on existing literature, the study finds that, from 1994 to 1996, and also in 1998, the rand’s real exchange rate became undervalued by an average 10%. By early 2002, the extent of overshooting had reached 20%. However, the strong recovery of the rand at the start of 2002 reversed this overshooting and instead pushed the real exchange rate above its equilibrium by an average 16 to 17% at the end of 2003. This suggests significant loss of trade competitiveness during 2003 and needed a nominal depreciation to correct the imbalance.