Exporters need weaker rand, but after inflation

THE recent fall in the rand exchange rate has been welcomed by Trade and Industry Minister Rob Davies. He believes it will give a much-needed boost to our sluggish manufacturing industries. This is because a weaker exchange rate reduces the cost of South African products in dollars, encouraging foreigners to buy our exports ahead of our competitors’.

A weaker exchange rate also increases the rand price of goods we import, such as clothing. This helps local producers compete with foreign rivals, increasing the amount we produce locally. When the prices of things we produce are set internationally in dollars, such as gold or platinum, foreigners pay the same dollar price for our products, but our producers receive more rands, encouraging increased output.

A strong exchange rate does the opposite. It weakens our ability to compete globally, reduces exports and undermines local production by encouraging imports.

The importance of an appropriately valued exchange rate is widely recognised. China, for example, has intervened heavily to prevent its currency from appreciating too rapidly. Its central bank stepped in and bought $3.5-trillion of its exporters’ foreign earnings. It believes a stronger exchange rate will slow the huge growth of manufacturing exports that has driven China’s rapid economic growth over the past 20 years.

In South Africa, the 1996 Growth Employment and Redistribution (Gear) strategy also recognised the importance of a weaker exchange rate. Building on the weakening of the rand in early 1996, Gear saw rapidly growing exports help lift growth to 5% a year. This belief was echoed in 2008 by the Harvard Group, which urged South Africa’s authorities to use interest rates and targeted intervention in the foreign exchange market to weaken the rand.

But a weaker exchange rate benefits exports only if the fall is in real terms — after inflation. If the rand prices of what we produce rise because of inflation by as much as the exchange rate weakens, our competitive position is unchanged. Thus major parts of the Gear strategy were aimed at ensuring that the weaker rand would not simply result in higher inflation.

Gear proposed reducing tariffs faster to ensure that prices of imports would not rise and called for modest wage increases to limit production cost increases. However, these recommendations were ignored and in less than a year the rand exchange rate was stronger in real terms than it was before its 1996 weakening. Most of this rise in real terms was because our prices rose much faster than those of countries with whom we trade. Unsurprisingly, the rise in exports Gear envisaged never happened.

What is the likelihood that things will be different this time? Will the increased competitiveness gained by a weaker rand be sustained, or will it be rapidly offset by rising prices locally? Past experience is not encouraging. We have a long history of the benefits of a weaker rand being fully offset within 12-18 months by higher domestic prices. As a result, even though the rand halved in nominal terms against the currencies of our major trading partners from April 1994 to December 2010, it was unchanged over this period in real terms.

Inflation is now above our target range and wage demands are much higher than that. Producers will be tempted at a time of rand weakness to grant wage increases substantially higher than inflation to avoid costly strikes. This will swiftly erode the competitive advantage gained by the weaker rand.

There are, nonetheless, important differences between the situation now and in 1996. The most important is the extent to which the rand has weakened. Since December 2010, the rand has fallen nominally by one-third against our trading partners. Our higher inflation means the fall is 25% in real terms. This is more than double the fall in 1996. It is greater than the fall during the 1998 Asian crisis and is almost on a par with the rand’s plunge in 2001.

Present rand weakness is part of a global phenomenon caused by concerns about tighter monetary policy in the US. India, Turkey, Brazil and Indonesia have also experienced sudden exchange rate weakness. It is possible these falls were overdone and there may be some correction. But rand recovery will be capped by the fact that South Africa has a large current account deficit.

Rand weakness has probably bought us a longer period of increased competitiveness than before, because the fall is greater. This advantage will nonetheless be eroded in two to three years by rising costs. The pickup in production will be modest because producers know the advantage is temporary. Ensuring a sustained competitive advantage is in all our interests.

This requires a single-minded focus on ensuring cost increases are limited so that the rand weakens not just nominally but in real terms.

This requires a degree of co-operation between business, labour and government that is sadly absent.

By Gavin Keeton

Keeton is with the economics department at Rhodes University.

Article Source: Business Day