THE REAL EXCHANGE RATE IN SOUTH AFRICA IS A HIGHLY CONTROVERSIAL ISSUE and has led to many opinions been

highlighted in the media on whether the Reserve Bank should interfere with the exchange rate or not. The basis of the argument for is that the Reserve Bank should devalue the Rand because this will aid in South Africas growth especially in the manufacturing sector. However the argument against the devaluing of the exchange rate is based on the opinions that the decline in the manufacturing sector is due to other factors such as high wages that are not positively related to levels of production in that sector .Therefore this essay will seek to address this issue on whether devaluing of the Rand will assist in economic growth. It will look at the different arguments that exist concerning the devaluation of the Rand. The real exchange rate(ER) is important where development and an employment creation are concerned especially where changes in the exchange rate lead to changes in the relative production costs hence having an impact on the allocation of labour within the manufacturing sector or any given industry. It is assumed that the manufacturing sector has a high degree of export orientation hence greater sensitivity to labour movements to the exchange rate. Also the manufacturing sector faces significant foreign competition hence has a high employment elasticity of exchange rates (Levy-Yeyati and Sturzenegger: 2003: 1173-1193). ARGUMENTS FOR THE DEVALUATION OF THE RAND The assumption is that the ER must be aligned with the appropriate specific outward-oriented industrial strategy that leads to the labour absorbing growth process. This is usually because the profits of the industry are linked to the changes in the exchange rate through the rate of capital accumulation in that specific sector (Ngandu, 2008:205-220). The depreciation of the Rand is mostly based on the argument of export led growth. The depreciation of the Rand will lead to the cost effectiveness of South African goods through the boosting of the domestic real income, output, net exports and improvements in the balance of payments. Devaluing the Rand means that there will be a decrease in imports relative to a larger increase in exports hence leading to expenditure switching of consumption toward South African domestically produced goods and also an increase in domestically produced products (Ngandu, 2008:205-220). The increase in domestic production together with the devaluing of the Rand and increase in the exports will, through the multiplier effect, lead to an increase in aggregate demand hence therefore increase in labour demand (employment) in to meet the increased AD. Furthermore a depreciation of the Rand will lead to an increase in the 1

overall price level, and holding nominal wage rates constant, this would mean an increase in the real wage rate and an increase in the demand for labour hence rise in employment levels.. This is usually the case if the monetary policy successfully addresses or prevents surges of inflation (Ngandu, 2008:205-220).

ARGUMENTS AGAINST THE DEVALUATION OF THE RAND Many of the arguments against the devaluation of the Rand arise from assumption of labour regulation rigidities, the adverse effects of depreciation, the high wages in the manufacturing sector that are not proportionally related to the level of production and that growth can be achieved through other means. Lets consider the point mentioned above that said the depreciation and expenditure switching and also increase on overall levels of price levels whilst real wages falls. It can be argued that devaluing the Rand does not guarantee that expenditure switching will occur. Additionally there is no assurance that as the overall price level rises that inflation can be curbed. Depreciating the Rand will lead to a drop in the price of intermediate goods and capital goods and instead of leading to increase to employment it might actually lead to unemployment as producers substitute labour for imported machinery (Ngandu, 2008:205-220). Furthermore the labour market rigidities that make it difficult to hire and fire employees makes it nearly impossible for changes in the exchange rate to lead to changes in the employment levels (Ngandu, 2008:205-220). Also the OCED report says that less restrictive product market regulation can increase employment creation and increase productivity growth and that employment strategy such as youth employment subsidies can be implemented (OCED, 2010:11).Structural reforms also need to be considered so as to address the wage rate rigidities found in the labour markets so as to increase labour demand when wage rates are linked to productivity. EMPIRICAL FINDINGS Other arguments address the fact that maybe South Africa should pursue other policies to achieve economic growth and employment creation. One would like to 2

conclude that maybe South Africa can take the stance that Mexico has taken that of real exchange rate targeting and inflation targeting. It has established a floor to prevent excessive appreciation of the Peso through intervention in the exchange rate market when the Peso hits this floor but in most cases the Peso floats freely ( Epstein, 2007:120). Additionally it has also been able to sort out one of the issues that South Africa faces that of excessive capital inflows in that speculators know that intervention will occur if the Peso reaches a certain limit so there is no incentive to overly invest. Another stance would be that South Africa adopt an employment targeting stance with its focus on the monetary policy, industrial policy, capital management techniques and identify an employment target that will be aligned with the rest of the policies in order to maintain moderate inflation rates and an acceptable exchange rate variability ( Epstein, 2007:1-20). In summary the high levels of unemployment and low growth in South Africa are both ultimately the result of the shrinkage of the non-mineral tradable sector since the early-1990s. Additionally the absence of sufficient real wage adjustment due to labour rigidities and informal sector growth as led to the decline in the demand for lowskilled workers which has resulted in high unemployment especially in the manufacturing sector. This has been due to a number of factors namely: a substitution towards skilled workers within each economic activity, significant structural change away from the most low-skill intensive parts of the economy, namely tradable and lastly within tradable the production techniques have become progressively more capital intensive (Rodrik, 2008:769797). What needs to be realised is that prices, costs and productivity are the main drivers of manufacturing production and employment therefore what South Africa need to do is set up a combination of monetary and fiscal policies that will allow the South African Reserve Bank (SARB) to run a modified inflation targeting framework which allows considerations of competitiveness to affect its decision-making. It SARB will need to develop views about the equilibrium real exchange rate which is satisfactory outcomes in terms of tradable output and employment and steer exchange rates accordingly. The objective here is to encourage private investment and entrepreneurship in new areas where South Africa can develop comparative advantage (Rodrik, 2008:769797). It can be said that South Africa first needs to `create a growth cycle that involves complementary increases in savings and exports so that increases in export are supported by increases in investment and savings so as to allow 3

for economic growth. When this has been achieved then consideration of devaluing the Rand can be taken (Akyuz and Gore, 2001: 265-288).