Investigating the Impacts of Real Exchange Rates on Economic Growth: A Case study of South Africa.

Abstract

This paper examines the impact of real exchange rates on economic growth in South Africa. The paper uses quarterly time series data for the period of 1994 to 2010. The Johansen cointegration and vector error correction model is used to determine the impact of real exchange on economic growth in South Africa. The explanatory variables in this paper are real exchange rates, real interest rates, money supply, trade openness and gross fixed capital formation. Results of the study reveals that real exchange rates have a dampening long run impact on economic growth in South Africa. From the regression results, it is noted that undervaluation of the currency significantly hampers growth in the long run, whilst it significantly enhances economic growth in the short run. As such, the policy of depreciating exchange rates to achieve higher growth rates is only effective in the short run and is not sustainable in the long run. Based on the findings of this study, the authors recommend that misalignment (overvaluation and undervaluation) of the currency should be avoided at all costs. In addition, the results of the study shows that interest rates also have a significant impact on growth and since interest rates have a bearing on the exchange rate, it is recommended that the current monetary policy of inflation targeting be maintained in South Africa. DOI: 10.5901/mjss.2013.v4n13p261