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Strong or Weak Currency for South Africa?

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Introduction

A strong currency is a currency whose value compared to other currencies is improving, as indicated by a decrease in the exchange rate, whereas, in contrast, a weak currency can be indicated by a significant depreciation in value over time against other currencies. South Africa`s economy with the currency at an almost three year high against the United States dollar, also characterised with a relatively weak economy and a strengthening currency finds itself in a unique position.

For South Africa, the debate seesaws between those who seek action to tame the rand and those who see the strong currency as a blessing.

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A strong currency yields higher economic growth and lower inflation as well as attract skills (Hart, 2011). On the other hand, labor unions fear a too powerful South African Rand could deter efforts to drive down the country`s 25 % unemployment rate. In line with the government`s policy of employment creates a weak rand can be the answer to the economy of South Africa through the reduction of the value of the rand (Cravern, 2011).

The need for a weak rand has also been noted by the Minister of Finance Mr. Pravin Gordan in his budget speech where he highlighted the need to put in place policies aimed to build the foreign exchange reserves and lowering debt to slow the strengthening currency.

Benefits of a Weak Rand in South Africa

A weak rand may grow South Africa`s exports as local products gain a competitive edge on the international market, hence, creating many jobs. This would have a positive effect on Gross Domestic Product (Madura, 2009:172). Furthermore, he points out that another potential benefit is the reduction of imports into South Africa.

This is due to a reduction in inflated costs that are incurred as a result of an unfavorable exchange rate. Moreover, a weak rand may stimulate and revamp the South African tourism industry as it becomes more attractive for most tourists from other countries to buy rands at fairly affordable exchange rates. This will translate into more employment prospects in South Africa, since; more people have to be hired temporarily or employed permanently to accommodate an influx in tourist’s attendant upon a weak South African Rand.

Also, it will promote foreign investments as it becomes cheap for foreign companies to start and establish their businesses in South Africa, as demand will be both high internally and on the international markets.

Shortcomings of a Weak Rand in South Africa

If the benefits of the weaker rand could be sustained and the improved competitiveness created jobs, the cost could be worthwhile. However, it’s unfortunate that a weak rand can haunt South Africa economically, socially, or even politically in the long-run as it only breeds short-lived benefits.

A weaker rand pushes up food and petrol prices, and a range of industries in other sectors take advantage of the weaker rand to expand their margins by pushing up prices by more than the currency has depreciated. An opinion piece in the Business Day (2010), noted that “A one-off, sharp weakening of the rand wouldn’t be inflationary. ” In fact, the data shows the pass-through from a gradual currency weakening is far lower than a one-off plunge and then, workers demand they be compensated for the rising inflation. As long as wage demands run at or above the inflation rate, the benefits of a weaker rand will quickly be eroded.

SA cannot simultaneously lower the cost of its labor in a global context and raise the real disposable income of local workers. The reason companies benefit from a weaker exchange rate is that it improves their competitiveness. Unfortunately, if wages rise by as much as the currency has weakened the benefits of the weaker rand are quickly lost. Therefore, unless unions agree to contain wage increases to below the inflation rate, and take a real cut in wages when the rand depreciates, any plans to forcibly weaken the exchange rate are pointless.

Madura (2009:172) indicates that the negative side of a weaker currency may include an upward inflationary pressure and increased prime lending rates by financial institutions. Thus, in the long-run foreign companies will be driven out of the market as local goods seem to be cheap for local consumers; however, faced with little competition than before, local producers will increase prices culminating in an inflation stricken economy. Also, a rand that is extremely weak would imply that most importers will seek domestic supply of goods.

Domestic suppliers then have more power and are able to increase the selling price of goods. Moreover, less home-grown business investments will flourish partly owing to deterring interest rates that shun more investments.

The Pros of Strong Rand in S.A.

Currencies rise and fall based upon the performance of the local economy and the sentiment of investors. If a currency is in vogue, speculators can push its value to excessively high levels. If it goes out of fashion, it could fall to extremely low levels. Sharp movements in a currency can have significant consequences for the economy.

In 2010 the rand was the third-strongest major currency in the world, due to uncontrollable factors like positive foreign investor sentiment, the favorable theme of emerging markets, attractive interest-rate differentials with the rest of the world, and slow recoveries and high debt levels in developed markets. This kept inflation in check, allowed interest rates to fall to 35-year lows, and consequently helped boost consumers’ incomes after a tough 2008-09 (Le Roux, 2011:3). A strong currency makes it cheaper for businesses in the country to import from foreign countries.

As a result of the currency is strong, it implies that foreign goods and services will cost less. The benefit of the goods and services that cost less will also trickle down to consumers. This is in the form of such low prices on goods imported. When a country’s currency is strong, companies that are export-driven are forced to become leaner and more efficient to compete in international markets. It would be cheaper for citizens of a country with a strong currency to travel abroad since the consumer would be getting more for their currency.

This usually makes things like food, hotels, and souvenirs cost less. Madura (2009, 172:173) asserts that a strong home currency has the potential to stimulate the consumption of imports by South African consumers and corporations. This is because a stronger rand relative to a particular foreign currency means that importers effectively incur a lower cost when importing goods. Madura shows how this would lead to intensified international competition and would leave domestic producers with limited room for price increases.

Domestic producers would have to remain within a certain selling price band in order to remain competitive. He further asserts that ceteris paribus, a stronger South African currency would lead to lower overall inflation rates (Madura 2009: 172:173). This would be beneficial to the economy in terms of improving the real purchasing power of money spent in the country. Madura (2009) explains how, as a result of South Africa viewing foreign prices as more “attractive”, a stronger currency would be a “possible cure for inflation”, but it could also lead to higher unemployment costs.

When the currency appreciates in its value, it will help source foreign products since the importing of such foreign products becomes cheaper, thus the domestic economy and consumers in particular benefit from currency strength. This is due to a decline in inflation rates and interest rates, as resources are more profitably used within the domestic activities of the economy. In addition, lower inflation leads to lower interest rates and bond yields, which means cheaper financing and lower debt servicing costs for the government, individuals, and companies.

Although a strong currency may result in short term declines of primary and manufactured goods revenues, the long-term benefits resulting from forced productivity and efficiency gains are seen to enhance long-run competitiveness. The key challenge is for such firms to remain operational during the initial period of currency appreciation. Indeed, firms can easily increase production once structural adjustments have been made, however, it is less plausible to reopen a production facility after it has been shut.

A strong currency increases the buying power of South Africans while making foreign products less expensive. South Africans are more confident and willing to spend when they feel richer and the cost of imported items is lower. So when the rand is strong, we tend to see the sale of imports rise in relation to exports.

Cons of a Strong Currency in S.A.

A strong currency will result in foreign businesses being less likely to import from a country with strong currency because they can trade more goods for their money with a different country that has a currency weaker than the rand.

However, South Africa is less likely to export goods when the rand is strong, thus, foreign demand for goods will decrease. When this happens, it tends to affect the South African companies by reducing their international sales. Generally, a foreign country will buy agricultural exports cheaper from a country with a weaker currency exchange rate than the South African rand. The result is that South African farmers will develop a surplus of crops, which may lead to lower prices. Getting less for what they produce is a disadvantage to farmers.

The South African trade deficit increases since we are importing more than we are exporting. This will also have a negative effect on South African manufacturers through the decline of local production. South Africa, as a developing nation, would like to attract foreign investment. If the rand gets too strong against major currencies, investment opportunities seem less attractive as it cost more to acquire. The South African economy relies heavily on mineral export (gold, platinum, etc) hence a strong currency will adversely affect the mining industry.

A strong currency increases the cost of South African goods on the global market. Exporters start to complain when the currency becomes too strong because South Africa is a major exporter. They fear its trade partners (namely China) will start to look for alternative import destinations. At that point, exporters would be faced with the tough decision of risking a fall in demand or reducing prices, which could drive down earnings and trade figures. A strong currency also negatively impacts South African companies selling products abroad.

A similar dynamic occurs in tourism where a strong currency encourages South Africa to travel abroad while deterring foreigners from traveling to South Africa. Hence a strong currency will reduce foreign profitability. The South Africa housing market has also received a tremendous boost from foreign demand, but a strong currency could curtail housing by reducing the value and attractiveness of South Africa real estate to foreign investors. Hence this will increase largely in the cost of housing. At the same time, a strong rand means that imported goods become relatively cheaper for South Africans.

This encourages people to buy foreign rather than local goods, which leads to further job destruction. It also encourages an overall increase in imports, which can have a negative impact on the country’s economic health.

Recommendation for South Africa Economy

A strong currency for South Africa can yield a long-run competitive economy which would in a way help to achieve the most crucial macroeconomic goal. Masia (2005) illustrates that the benefits of a stronger currency, we will consider a currency transmission mechanism, in which the cost of production or importation of raw materials is affected by the exchange rate.

A stronger exchange rate is ideal for South Africa as it results in lower costs of production, thereby limiting the price increase passed on to intermediaries. These goods are thus able to be sold to the end-user at a discounted price compared to the case of a weak currency. This subdued level of price increases for end-user products is directly transmitted into overall consumer prices. Under benign inflationary conditions, the necessity to tighten monetary policy is reduced, thus stimulating the private sector.

This stimulation results in increased levels of effective consumer demand increased income level, and wealth creation. Coupled with prudent monetary policy, benign inflationary conditions can be sustained. However the cycle is virtuous with increased private sector activity and profit creation, the desire for institutions to expand and reap further profits leads to investment. Such investment takes the form of expansion of the labor force, increasing utilization capacity, or opening of new subsidiaries. Furthermore, positive spillover effects occur when expanding through adding to the capital stock.

This creates employment opportunities, thus increasing income. Moreover, an economy that is experiencing high levels of effective demand and consumer activity significantly increases the resources available to the government through the retention of income tax receipts. Higher levels of government revenue enable expansionary policies by the government, thus providing additional funding for skills and welfare development. Investment in education, technology, social aid, and community projects are all welfare supportive and are made more realistic by the availability of funds.

Although a strong currency may result in short term declines of primary and manufactured goods revenues, the long-term benefits resulting from forced productivity and efficiency gains are seen to enhance long-run competitiveness. The key challenge is for such firms to remain operational during the initial period of currency appreciation. Indeed, firms can easily increase production once structural adjustments have been made, however, it is less plausible to reopen a production facility after it has been shut.

Conclusion

In light of the above discussion its suffice to say that advocating for a weak or strong currency presents noticeable merits and drawbacks, but, it is imperative that a strong rand in South Africa be embraced as it suits the economic outlook and may be sustainable in the long run. However, the implications of a strong currency in South Africa must be taken into account as South Africa stand to lose on Foreign Direct Investments due to the strength of the rand. If the rand is weakened it is viewed as an opportunity for foreign investors to purchase assets at a reduced cost, thereby increasing FDI IN SA (Blonigen,1997).

References

  1. Blonigen, B. A. 1997. Frim-Specific assets and the link between exchange rates and foreign direct investment. The American Economic Review, 87(3):447-465.
  2. Hagedorn, S. 2010. Peg the rand to give SA a fighting chance. [Online]. Available: http://www.businessday.co. za/articles/Content.aspx? id=108808 [ 20 September 2011].
  3. Hart; Craven. 2011. Strong Rand-Blessing or Curse. [Online]. Available: http://www.dalmax.co.za/news/strong-rand-blessing-or-curse/ [10 September 2011].
  4. Kiat, J. 2008, The Effect of Exchange rate and inflation on foreign direct investment and its relationship with economic growth in South Africa. Pretoria: Gordon Institute of Business Science.
  5. Madura, J. 2008. International Financial Management. 9th Edition: Cengage Learning.
  6. Masia, A. 2005. Economics Society of South Africa. Bi-Annual Conference, Kwazulu-Natal: Elangeni Holiday Inn.
  7. Masia, A. 2005. Currency Value Effects on the South African Economy and Estimation of its Underlying Equilibrium Level. Kwazulu-Natal. [Online]. Available: http://www.essa.org.za/download/2005Conference/Masia. pdf [16 September 2011].

Cite this Strong or Weak Currency for South Africa?

Strong or Weak Currency for South Africa?. (2019, May 01). Retrieved from https://graduateway.com/strong-or-weak-currency-for-south-africa/

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