The determinants of the exchange rate volatility: A case study for South Africa

Abstract

The dissolution of the Bretton Woods system in 1973 prompted numerous countries to shift from fixed to flexible exchange rate regimes, resulting in increased exchange rate volatility. In line with this global trend, South Africa adopted a free-floating exchange rate system in the mid-1990s and implemented an explicit inflation-targeting framework in the early 2000s. This policy transition, which emphasized the internal value of the rand, inadvertently led to increased exchange rate volatility. Excessive exchange rate volatility delays investment decisions, causing economic uncertainty and negatively impacting economic growth by impacting investment and investor confidence, productivity, consumption, international trade, and capital flows. Despite various factors suggested in the literature, there is no consensus on the primary causes of exchange rate volatility, making it a contentious issue. Notably, there is a paucity of studies examining this topic within the South African context. This study aims to contribute to the existing literature by analyzing the determinants of exchange rate volatility in South Africa, employing the Nonlinear Autoregressive Distributed Lag (NARDL) approach and utilizing quarterly data spanning from 2000 to 2023. The findings suggest that trade openness has a significant impact on exchange rate volatility, underscoring the need for policies that consider the complexities of trade integration and its impact on exchange rate stability. The findings suggest that trade openness has a significant impact on exchange rate volatility, underscoring the need for policies that consider the complexities of trade integration and its impact on exchange rate stability. Policymakers should advance trade liberalization, secure favorable agreements, and lower barriers to diversify export markets and reduce dependence on limited trading partners, thereby stabilizing the exchange rate.