An assessment of the role of real exchange rate on economic growth in South Africa (1994-2015)

Abstract

The choice of a weak or strong currency has been at the center of the debate in most developing economies as exchange rates play a vital role in a country’s level of economic growth. This growth is critical to many developing economies. The study assessed the role of real exchange rate on economic growth in South Africa from 1994, first quarter, to 2015, fourth quarter. The study used time-series data in which Augmented Dicky Fuller and Philip Perron tests for stationarity, cointegration test, Vector Error Correction Model (VECM) approach for the long-run relationship were conducted. Impulse Response Function (IRF) and Variance Decomposition (VD) were also conducted to explain the response to shock amongst variables and how much of the forecasting error variance is explained by the exogenous shocks to other variables. VECM results showed a positive role exchange rates play on economic growth in South Africa. The study’s implication is that currency devaluation (exchange rates depreciation) can be effective in improving economic growth in the short-run. Nonetheless, a strong currency is good for economic growth in the long-run as it attracts foreign investments and a good instrument for controlling inflation. Thus, basing on the findings of the study, the floating exchange rate system adopted by South Africa in 2000 can be maintained.