THE rand is approaching record lows against the dollar. Why then is the output of our major export sectors, mining and manufacturing, not responding? Why is SA’s economic growth slowing instead of being boosted by increasing production of exports if the things we produce are now much cheaper for foreigners to buy? There are no simple answers. The exchange rate is an important determinant of our export performance, but it is not the only thing that matters.
The exchange rate matters because potential overseas buyers of our products translate the rand prices of what we sell into their own currencies and compare these with the prices of what they produce themselves or can purchase from other countries. When the rand exchange rate weakens, our prices become cheaper in foreign currencies. Our global competitiveness therefore improves.
But this will translate into increased exports only if that improved competitiveness is sustained. If rand prices rise rapidly because of inflation, the benefit from falling prices in global currency terms is quickly reversed. For improved global competitiveness to last, it is essential that the rand exchange rate remains weaker even after allowing for inflation — this is called a fall in real terms.
Inflation in SA is quite high by global standards, so some of the competitive advantage of the weakening exchange rate is lost because our local prices rise faster than those in our competitor countries. So, for example, while the rand has fallen 32% in nominal terms since January 2010, after taking inflation into account, the fall is only 22%.
This is still a big fall. But if we started with a situation in January 2010 where the prices of local products were much more expensive than those of our competitors, they would still be more expensive than those of our rivals, despite the weaker rand.
In some areas, our products may have only recently become cheaper than those of our rivals, because half of the 22% fall in the rand in real terms occurred in the past six months. Hence, it is too early to expect the rand’s fall in the past few weeks to affect global demand for our goods.
Moreover, even if foreign demand for our now cheaper products has risen, there is no guarantee we will export more. If exporters believe this improved competitiveness and demand is only temporary, they will be reluctant to increase export production capacity for only short-term gains.
Past experience confirms this. Since 1994, the rand weakened sharply on four previous occasions. In 1996, 2001 and 2008, the real exchange rate returned to its pre-crisis levels within 12-18 months. Producers who had expanded their exports found that their improved global competitiveness disappeared and they could not profitably sell what they produced. Only after 1998 was rand weakness sustained for some time and exports benefited, but even this advantage was eventually wiped out when the rand began strengthening in 2003. By 2006, it was stronger in real terms than in 1997.
At present, our exports are weak also for reasons unrelated to the exchange rate. We are affected by the economic weakness of our largest foreign market, the European Union. The shortcomings in our transport infrastructure needed to carry goods to our ports and our inadequate electricity supply are further factors. Indeed, to reduce demand for electricity, Eskom is actually paying metals smelters to reduce production they would otherwise export. Coal exports have only recently recovered to the levels of 2005, when prices were much lower, because of problems in getting coal by rail to Richards Bay.
Finally there are production losses because of persistent strikes in mining that, together with falling commodity prices globally, have crippled production of SA’s largest export sector. Mining production is still lower than it was in 2007 — before the start of the global financial crisis.
So while the level of the exchange rate is unquestionably important to our global competitiveness, it is not a “silver bullet” that can overcome all these other problems.
For most exporters, the level of the rand must now be highly favourable. But to take advantage of this, they must first overcome their in-built suspicion that this new competitiveness will not be sustained. Could this reality be changed? Could the level of the rand be “locked in” in real terms?
Recent experience in countries such as Brazil shows that attracting “just the right amounts of foreign capital” is almost impossible to achieve. So, for as long as SA remains dependent upon volatile global capital inflows to compensate for our lack of domestic savings, the answer is that achieving this will be difficult indeed.
By Prof Gavin Keeton.
Source: Business Day
Keeton is with the economics department at Rhodes University.