During the past few weeks the rand-dollar exchange rate has been in the news. Analysts are tweeting the all-time lows and debating to what extent this will boost exports and “import inflation”. Minister Gordhan said at the WEF in Davos: “The test is for private sector firms to demonstrate their agility and responsiveness to what are favourable conditions.”.
We have written about the strength of the rand on this blog before and would like to add some perspectives from the academic literature, drawing on an excellent paper Lawrence Edwards and Robert Garlic.
The first step is to think about the channels through which the exchange rate affects exports.
- The supply of exports is positively related to the rand price of exports. So if the rand depreciates against the dollar, exporters get more rand for every dollar.
- Relative to domestic costs and prices, exporting is now more profitable and the companies supply more exports.
- The nature of this export response depends on the elasticities of export demand and supply – i.e. how sensitive supply and demand is to changes in the exchange rate.
- If domestic exporters are price takers in the international market, they will simply sell greater volumes of their product at the international dollar price. The full depreciation adds to the profitability of their exports (a 20% depreciation makes their exports 20% more profitable). The increase in export volumes will depend on how competitive the firms are.
- If the exporters can influence the world price of their products, they will pass through some of the depreciation to their foreign buyers in the form of a lower dollar price. In this case exports increase for two reasons: the increase in the relative profitability of the export supply and an increase in the quantity demanded by foreign consumers. In this case the more competitive exporters can use the depreciation to try and capture market share.
What the minister calls agility and responsiveness to favourable conditions, is also known as competitiveness and this is strongly influenced by the inflationary impact of a nominal depreciation. It may be that the benefits are offset by increases in exporters’ production costs:
- The depreciation increases the costs of imported inputs.
- Suppliers may increase their prices in response to the high profit margins of the exporters or in response to their own supply constraints.
- Rising consumer prices can lead to demands for increased wages.
The end result could be a very short-lived or muted export supply response to a depreciation of the exchange rate. There may also be important differences between sectors.
But what does the evidence show?
At an aggregate level there is a positive association between exchange rate depreciations and export performance. Edwards and Garlic lists the results from a range of studies and show that “a one percent rand depreciation is estimated to raise long-run manufacturing exports by 0.78 to 1.38 percent”. But this aggregate relationship fails to capture changes in competitiveness at the sectoral level. Their evidence shows that primary products are less responsive to exchange rate shocks than manufactured products. Non-gold merchandise exports (including manufacturing) are less responsive to exchange rate shocks than manufacturing alone. There are also differences across manufacturing sectors: the export response in natural resource-based and machinery & metal products sectors is generally lower than in labour intensive, chemical-intensive beneficiated sectors. And what about the channels through which the exchange rate affects exports? The evidence shows that South African exporters of manufactured goods are price takers in the international market. That means that export growth is not constrained by inelastic foreign demand or an inability to price competitively in the international market. This sound like promising news the minister would like to hear, but as always there are caveats:
- The extent of an export boom depends on the composition of exports. Historical evidence showed that manufactured exports are likely to benefit more than commodity exports, but looking at the nature of South Africa’s top-20 exports (from Edwards & Alves in SAJE, 2006) one sees that manufactured exports make up a small part of the mix.
- The length of an export boom depends on competitiveness, specifically on the cost of imported inputs and labour. The evidence shows that nominal depreciations have not sustained the profitability of exports. Domestic producer prices are very responsive to changes in the exchange rate – a 1 percent rise in import prices has raised domestic producer prices by between 0.85 and 1 percent in the long run.
In addition, all this says nothing about whether a depreciation-driven export boom will translate into increased employment, up-skilling of workers, or development of local suppliers. In sum, the depreciation of the rand creates an export windfall; it is not a growth and development plan.