The Impact of Exchange Rate Volatility on South African Manufacturing Trade Flow (2008-2023

Abstract

The failure of the Bretton Woods arrangement of stable exchange rates has resulted in the existence of a new form of foreign exchange rate uncertainty or volatility, which has since drawn the attention of numerous economic modellers and researchers due to its known adverse impacts on international trade. This research study is aimed at investigating the influence of foreign exchange rate volatility on the manufacturing trade of South Africa using export and import econometric models and economic data spanning January 2008 through December 2023. The study used data containing several macroeconomic variables, including manufacturing imports and exports, and econometric models such as the GARCH model (for measurement of volatility in foreign exchange rate) and the import and export time series regression models to estimate the impact of volatile currency exchange rate on cross-border trade flows. Methods for conducting unit root tests including Phillips-Perron and Augmented Dickey-Fuller indicated that the foreign exchange, interest and inflation rates as well as trade variables were initially non-stationary, but stationarity was achieved after taking the first difference, confirming their suitability for regression analysis. Johansen cointegration analysis identified two and one cointegrating equation(s) for the import and export models respectively at the 5% significance level, confirming long-term stability in trade flows’ relationships with macroeconomic variables including foreign exchange, inflation, and interest rates. This study’s results showed that volatile foreign exchange rate significantly influenced both log-transformed export and import variables, supporting the initial hypothesis that manufacturing trade flows are affected by volatilities in foreign currency exchange rate. While the foreign currency exchange rate level itself had an insignificant effect on manufacturing exports, its volatility had a strong impact. Similarly, foreign exchange rate had a weak adverse impact on imports, while its volatility showed statistically significant effects. Diagnostic tests confirmed the robustness of the models, showing consistent residual patterns and the absence of autocorrelation or serial correlation. The study provides valuable insights for evidence-based policy formulation and recommends that policymakers adopt strategies to mitigate the adverse effects of uncertainty or volatile foreign exchange rate. It further highlights the significance of stable exchange rates in supporting sustainable trade. By focusing on the manufacturing sector for South Africa and employing advanced econometric tools, this study enriches the limited body of empirical work on exchange rate volatility in developing economies and offers practical policy recommendations.