The determinants of long-run real exchange rates in South Africa: a fundamental equilibrium approach

Abstract

In this paper, we identify the fundamental determinants of the long-run exchange rates in South Africa. We then estimate the equilibrium real exchange rate for this country using a dataset covering the period 1975-2012. In order to account for possible short-run fluctuations in the real exchange rate, we conducted a cointegration test using the ARDL bounds-testing procedure. First, we found terms of trade, trade openness, government consumption, net foreign assets and real commodity prices to be the long-run determinants of the real exchange rate in South Africa. Second, we found that nearly 68.06 per cent of the real exchange rate disequilibrium is corrected annually. Overall, the estimated equilibrium exchange rate indicates that the Rand has been depreciating in real terms over the years. Tightening trade openness is not an option, given international agreements; on the other hand, terms of trade and real commodity prices are determined by the world market. The obvious policy alternative is for South Africa to increase government spending and moderately decrease her net foreign asset position.