The impact of the real effective exchange rate on South Africa's trade balance

Abstract

With the South African Rand (ZAR) recording record lows against most major currencies throughout 2014 coupled with a persistent trade deficit in the BOP, the purpose of this paper is to ascertain the impact of the real effective exchange rate on South Africa’s trade balance and whether the J-curve phenomenon and the MarshalLerner condition are satisfied in the South African economy. The bounds test and Johansen cointegration test results show that there is a long run equilibrium relationship between the trade balance, real effective exchange rate, domestic GDP, money supply, terms of trade and foreign reserves. The results show that a depreciation of the ZAR improves the trade balance in the long run, thus confirming the Marshal-Lerner condition. In the short run, a ZAR depreciation leads to a deterioration of the trade balance, thus confirming the J-curve effect for the RSA economy.

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