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We take a look at the impact a strong Rand has on South Africa's trade deficit. In the past we have written about this and received some flack for it due to various economist arguing casaulity was not tested. While this was true, critics missed the point we were making. South African imports are more inelastic than its exports. I.e. South Africa will import crude oil regardless what it's price is because it is an essential product. Exports of South African fruit for example can be stopped by any country without to much fuss if they feel our prices for it is to high as they can get fruit from most countries. Thus our argument was that South Africa needs a stronger Rand (to make imports cheaper), even if it reduces demand for our now more "expensive" exports. The net effect on our economy via our Trade balance will positive for the country.
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The graph that says it all
The graphic below shows South Africa's trade balance each month as well as the corresponding exchange rate for that specific month. As can clearly be seen from the graph, when the Rand is stronger South Africa's trade balances are better off (positive). I.e the value of our exports surpasses that of our imports. As the Rand weakens, our trade balance becomes worse off (negative). I.e the value of our imports exceeds that of our exports.
However economic theory dictates that a weakening exchange raet should have a positive impact on a country's trade balance as it makes imports more expensive (so a country will import less due to it being more expensive) and a country will export more (since a weak exchange rate makes a country's exports cheaper for other countries to buy). And this net effect will boost a country's trade balances. So economic theory suggests a weak exchange rate is good for a country's exports and it trade balances. But why is this not the case for South Africa? It is clearly not the case as the graphic above shows as our currency gets weaker so our trade balance gets worse.
Well a big part of that has to do with the type of products we import and export. Earlier in the year we wrote the following "
So the question is, why does economic theory regarding a weakening exchange rate's impact on trade balances not hold true for South Africa?
So is government and the South African Reserve Bank (SARB) aware of this? Do they realise that economic theory hammered into economics and business school students does not necessarily hold true for South Africa? Should we not try and set policies that will ensure a stronger currency? (We are playing devils advocate with this question. But someone has to ask it)."
So the question is, why does economic theory regarding a weakening exchange rate's impact on trade balances not hold true for South Africa?
- Demand for South African exported goods (mostly commodities such as coal and platinum) are not completely inelastic. Demand has dropped off in recent years and combined with this there has been less capital inflows from foreigners into SA. In fact there has been large scale capital outflows in recent months, putting immense pressure on the exchange rate. Companies are no longer expanding or investing in South African businesses (in particular our mines). This is largely due to lack luster returns earned on commodities over the last two years. Less investment in a country leads to less demand for that country's currency and therefore a weaker exchange rate.
- Demand for imported goods are more inelastic than the demand for our exported goods. South African manufacturers/consumers still require and consume foreign made goods (even though the Rand price of importing such items are increasing the demand for these are not falling due to increasing prices). Thus demand is inelastic as its not affected a lot by price increases.
- To put the above differently, we are exporting non-essential goods (I.e country's can survive without some of our larger exports (coal, iron ore, platinum etc.)), while we cannot survive without the goods we are importing. Think about this, South Africa exporting platinum vs South Africa importing Crude oil. At any given point a country can survive without importing platinum from South Africa, can South Africa survive by not importing Crude oil from Nigeria, Angola, Saudi Arabia etc? Not likely.
So is government and the South African Reserve Bank (SARB) aware of this? Do they realise that economic theory hammered into economics and business school students does not necessarily hold true for South Africa? Should we not try and set policies that will ensure a stronger currency? (We are playing devils advocate with this question. But someone has to ask it)."
And our view mentioned above remains the same. We remain convinced that a stronger Rand is better for South Africa's trade balances than a weaker one. And the numbers dont lie. They tell the story pretty clearly.