Abstract
M.Comm. (Economic Development and Policy Issues)
The response of the trade balance to changes in currency movements has gained increasing interest among researchers, especially since the fall of the Bretton Woods system. Previous empirical studies that examined the response of the trade balance to exchange rate changes in South Africa employed aggregate trade data and provided mixed results. This dissertation uses disaggregated data with specific focus on the manufacturing sector. The purpose is to investigate the short and long run effects of the real exchange rate of the rand on the South African manufacturing trade balance by adopting the elasticity approach of balance of payments adjustment. Using quarterly data from 1995 to 2010, the study seeks to test the existence of the J-curve effect and to show whether the Marshal–Lerner condition holds in the manufacturing sector. Johansen cointegration and vector error correction modelling techniques are employed in attaining the objectives of this study. In addition, impulse response functions are used to determine how the manufacturing trade balance responds following shocks in its main determinants.
The results show that real effective exchange rate (REER), real domestic and foreign income levels are important long run determinants of the manufacturing trade balance, and that a long run equilibrium relationship exists among these variables. A long run negative relationship was found between the trade balance and the REER and between the trade balance and real domestic income. In contrast, real foreign income was found to be positively related to the domestic manufacturing trade balance in the long run. The short run model reveals that a depreciation in the domestic currency results in a deterioration in the manufacturing trade balance. This, together with the long run findings, suggests evidence of the existence of the J-curve in the South African manufacturing trade balance. The long run dynamics suggest that the Marshal–Lerner condition holds. This dissertation found evidence that a depreciation of the rand is necessary to improve the manufacturing trade balance.