Is SADC an optimal currency area? Evidence from the generalized purchasing power parity test

Abstract

In this paper we investigate the likelihood of a proposed monetary union in the Southern African Development Community (SADC) from the view point of the generalized purchasing power parity (GPPP) hypothesis and optimum currency area theory. We apply Johansen’s multivariate co-integration technique. The findings from this study confirm that GPPP holds among SADC member countries included in this study on account of cointegration and stationarity in real exchange rate series. South African rand normalized long run beta coefficients of all the real exchange rates are below one except in the case of the Mauritian rupee and all bear negative signs except in the case of the Angolan New Kwanza and Mauritian rupee. This is evidence that supports monetary union in the region except for Angola and Mauritius. Moreover, the panel cointegration tests also confirm the cointegration among real exchange rate series of SADC countries. However, the absolute magnitudes of the short run adjustment coefficients of SADC countries’ real exchange rates are low and bear positive signs in some cases. This finding implies that the observed slow speed of adjustment for (log) real exchange rate of SADC member states might constrain the effectiveness of stabilization policies in the wake of external shocks, rendering SADC countries vulnerable to macroeconomic instability in the region. This result has important policy implications for the proposed monetary union in SADC.