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In this article we compare South Africa's trade balance and the cumulative trade balance with the Rand-Dollar exchange rate. Economic theory dictates the stronger a local currency the worse a trade balance will get as imports become cheaper and exports become more expensive, but is it the case for South Africa?
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Comparing South Africa's trade balance to the Rand-Dollar exchange rate
The graphic below shows the monthly trade balance (difference between the value of goods exports and goods imported) for South Africa per month from the start of 2014 as well as the monthly average Rand-Dollar exchange rate.
As mentioned in the introduction the basic economic theory is that the stronger a country's local currency the worse their trade balance will be, as the a stronger exchange rate makes imports cheaper and exports more expensive, so the country in question will import more and export less which will negatively affect a country's trade balance. But the question is whether this basic economic theory applies to South Africa or not?
The gray line shows the cumulative trade balance for South Africa from January 2014, the blue line shows the Rand-Dollar exchange rate and the red an green graphic shows South Africa's monthly trade balance. Red shows a trade deficit (South Africa exported less than what it imported) and green shows a trade surplus (South Africa exported more than what it imported).
The gray line shows the cumulative trade balance for South Africa from January 2014, the blue line shows the Rand-Dollar exchange rate and the red an green graphic shows South Africa's monthly trade balance. Red shows a trade deficit (South Africa exported less than what it imported) and green shows a trade surplus (South Africa exported more than what it imported).
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So the economic theory is that as the exchange rate (blue line) gets weaker (shoots up in the graphic above), the trade balance and the cumulative trade balance should improve, as a weaker exchange rate makes imports more expensive and exports more affordable. But as the graphic shows during 2014 and 2015 as the exchange rate (blue line) shoots up (weakens) the trade balance gets worse, which is in contrast to the basic economic theory that a weaker exchange rate leads to improved trade balances.
So the question is why is this the case? The main reason for this is the composition of South Africa's imports and exports and the pricing behaviour of international commodity prices (but more about this later). Lets cover the composition of South Africa's imports and exports first to understand how this affects South Africa's overall trade balance.
Composition of South African exports. South Africa's exports is largely commodity and basic materials based. The bulk of South Africa's exports is made up by Coal, Gold, Platinum and other basic commodities such as iron ore. The price of these items are set on the international markets and is mostly quoted in US dollars. So the price received for these commodities is international market price and exchange rate dependent. In 2014 and 2015 while the South African Rand depreciated considerably the international prices of various commodities including gold, coal and platinum declined significantly, which reduced the benefit for South Africa in terms of export gains due to a weaker exchange rate as the price received for South Africa's main export commodities declined. However it was not all bad news for South Africa. as one of its main imports products, crude oil saw a massive slump in its price in early 2015, which meant even with a weaker exchange rate the price paid for crude oil of of South Africa's major imports declined significantly from over $100 in mid 2014 to under $50 in January 2015.
So money received for exports declined but so did the price paid for one of South Africa's major exports, even with a significantly weaker exchange rate. So why is this? Well some of South Africa's main exports other countries caan to be honest, live without. Most of the large export commodities we export is not essential for other countries to keep operating and running smoothly. The thing is can South Africa say the same about crude oil? Can we live without it? The short answer is no, and South Africa's economy will come to a grinding halt. And demand for crude oil from South Africa will always be high, but demand for our main exports such as gold, platinum, iron ore, coal is far more volatile.
And this is part of the problem for South Africa's trade balance. When demand for our exports declines and the prices decline, the demand for some of our imports such as crude oil remains high, even if the price is volatile. And the net effect of this is that total rand value earned for our exports is less than the rand value paid for crucial imports such as coal, and this leads to a negative trade balance even when the exchange rate weakens.
Looking at the recent trend in the exchange rate and trade balance and the cumulative trade balance we see a weakening of the exchange rate is linked to a improving trade balance as economic theory suggested. So why the change in recent times when in 2014 and 2015 it did the opposite. Well the price of South Africa's main export products has been going up gradually in recent times while the price of crude oil has remained relatively stable. So with a weakening exchange rate and prices of South Africa's main export commodities going up the net gain in South Africa's exports outweighs the slight increase in the cost of crude oil due to a weakening exchange rate, and this has lead to a substantial improvement in South Africa's trade balance in recent times.
So while the economic theory is pretty simple that a weaker exchange rate leads to improved trade balances, and visa versa, it is not always as simple as that and there are a number of factors that plays a role and in the case of South Africa the price of its main exported and imported commodities as well as the demand for these plays a significant role in the total value of goods being imported and exported on a monthly basis and this has a impact on the monthly trade balance of South Africa.
So the question is why is this the case? The main reason for this is the composition of South Africa's imports and exports and the pricing behaviour of international commodity prices (but more about this later). Lets cover the composition of South Africa's imports and exports first to understand how this affects South Africa's overall trade balance.
Composition of South African exports. South Africa's exports is largely commodity and basic materials based. The bulk of South Africa's exports is made up by Coal, Gold, Platinum and other basic commodities such as iron ore. The price of these items are set on the international markets and is mostly quoted in US dollars. So the price received for these commodities is international market price and exchange rate dependent. In 2014 and 2015 while the South African Rand depreciated considerably the international prices of various commodities including gold, coal and platinum declined significantly, which reduced the benefit for South Africa in terms of export gains due to a weaker exchange rate as the price received for South Africa's main export commodities declined. However it was not all bad news for South Africa. as one of its main imports products, crude oil saw a massive slump in its price in early 2015, which meant even with a weaker exchange rate the price paid for crude oil of of South Africa's major imports declined significantly from over $100 in mid 2014 to under $50 in January 2015.
So money received for exports declined but so did the price paid for one of South Africa's major exports, even with a significantly weaker exchange rate. So why is this? Well some of South Africa's main exports other countries caan to be honest, live without. Most of the large export commodities we export is not essential for other countries to keep operating and running smoothly. The thing is can South Africa say the same about crude oil? Can we live without it? The short answer is no, and South Africa's economy will come to a grinding halt. And demand for crude oil from South Africa will always be high, but demand for our main exports such as gold, platinum, iron ore, coal is far more volatile.
And this is part of the problem for South Africa's trade balance. When demand for our exports declines and the prices decline, the demand for some of our imports such as crude oil remains high, even if the price is volatile. And the net effect of this is that total rand value earned for our exports is less than the rand value paid for crucial imports such as coal, and this leads to a negative trade balance even when the exchange rate weakens.
Looking at the recent trend in the exchange rate and trade balance and the cumulative trade balance we see a weakening of the exchange rate is linked to a improving trade balance as economic theory suggested. So why the change in recent times when in 2014 and 2015 it did the opposite. Well the price of South Africa's main export products has been going up gradually in recent times while the price of crude oil has remained relatively stable. So with a weakening exchange rate and prices of South Africa's main export commodities going up the net gain in South Africa's exports outweighs the slight increase in the cost of crude oil due to a weakening exchange rate, and this has lead to a substantial improvement in South Africa's trade balance in recent times.
So while the economic theory is pretty simple that a weaker exchange rate leads to improved trade balances, and visa versa, it is not always as simple as that and there are a number of factors that plays a role and in the case of South Africa the price of its main exported and imported commodities as well as the demand for these plays a significant role in the total value of goods being imported and exported on a monthly basis and this has a impact on the monthly trade balance of South Africa.