Abstract
The objective of this study was to investigate the relationship between real exchange rate and economic growth in South Africa. Using time series data, the period from 1980 to 2015 was covered in the study. Data was collected from the South African Reserve Bank, the International Monetary Fund and International Financial Statistics. The Johansen cointegration and the Vector Error Correction Model estimation techniques were employed in the study, followed by VEC Granger causality test, variance decomposition and impulse response function. The long-run results revealed a negative and significant relationship between real exchange rate with export and economic growth. On the other hand, money supply and foreign direct investment have a positive and significant relationship with real exchange rate. Only export was significant and positively related to real exchange rate in the short-run. Results of granger causality showed that only export granger causes real exchange rate thus, a unidirectional causality exists between export and real exchange rate. Results of variance decomposition revealed that the real exchange rate is highly affected by shocks from economic growth. The impulse response functions showed that real exchange rate responds positively to shocks from real exchange rate and money supply. On the contrary, real exchange rate responds negatively to a shock from economic growth. There is, therefore, a need to increase exports, money supply, foreign direct investment and economic growth as these would lead to an increase in the Rand and consequently, appreciation of the Rand.
Highlights
The relationship between exchange rate (ER) and economic growth (EG) has remained a controversial subject
The error correction term is negative (-0.305) with an absolute t-statistics of 4.051. This proves that only 30% equilibrium is corrected in the period as it moves towards restoring equilibrium
Only LNEXPO granger causes LNRER since the probability value is less than 5%, an indication that changes in LNEXPO do affect LNRER
Summary
The relationship between exchange rate (ER) and economic growth (EG) has remained a controversial subject. During the 2012 financial year, the Rand began to decrease against the United States Dollar; depreciating at 9 % average level rate of exchange (Census and Economic Information Centre Data, 2016). In the 2015 financial year (between January and March), the decrease in the value of the currency was recorded at a rate of 12.45% (Trading Economics, 2015). In January 2016, it took a hard hit when it recorded its all-time high of R16.84 to the Dollar (Maepa,2015). This was mainly due to South Africa’s political instability and the replacement of the Finance Minister, Nhlanhla Nene, with African National Congress (ANC) Member of Parliament, David Van Rooyen on 9thDecember 2015. The exchange rate, has to maintain its stability for the economy to gain from international trade and to increase the growth rate of the economy
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