In the past few years, South Africa’s currency has gained recognition as one of a handful of the world’s traded commodity currencies. This term applies in countries where the world commodity price of the country’s commodity exports has an important effect on their real exchange rate.
Two studies published late last year both found that the South African rand fits the bill of a commodity currency. Other countries in this group are Australia, New Zealand and Canada.
Minerals have long been important in South Africa’s economy, said Standard Bank group economist Goolam Ballim. In the 1980s, commodities made up 65% of South Africa’s export basket. Currently, the figure is about 40%, he said.
Despite this apparent reduction in commodities’ share of exports, Ballim said they are still significant for the South African economy.
Other analysts say that statistics on commodities tend to exclude refined base metals such as raw steel or aluminium. If these are included, the share of minerals in South ÂÂAfrica’s exports is still more than 50%.
Another change has been the composition of South Africa’s mineral exports and the declining importance of gold. Ballim said that platinum exports have overtaken the level of gold exports, while coal exports are roughly equivalent to gold.
Economists and business people engaged in trade are aware that exchange rates can have significant implications for monetary and industrial policy. In South Africa, manufacturing surged when the rand hit a record-low in 2002. Later, in 2004, employers and employees in the mining industry took to the streets in a joint demonstration against the appreciating rand.
Ballim said that a renewed interest in the correlation between commodity prices and the exchange rate in South Africa was due to a surge in commodity prices and the related boost in the country’s terms of trade in the past few years.
Yet forecasting exchange rates is incredibly difficult. ”For decades, economists have tried with little success to model long-run movements in real — that is, adjusted for inflation — exchange rates,” wrote Paul Cashin et al in an article titled ”Commodity currencies” in the International Monetary Fund’s quarterly magazine.
Academics Yu-chin Chen and Kenneth Rogoff, from the United States, describe the relationship between economic fundamentals and exchange rates as an ”elusive connection” and ”one of the most controversial issues in international finance”.
The exchange rate movements of commodity currencies, however, are by definition more open to explanation than most other currencies. This is because the exchange rate tracks the world price of the country’s key commodity exports.
In an article on South Africa’s macroeconomic challenges a decade after democracy, Jeffrey Frankel et al found that this relationship between exchange rates and commodity prices can be seen to exist in South Africa.
The paper is one of several articles by economists from Harvard University and local universities commissioned by the National Treasury to inform the government’s accelerated and shared growth initiative for South Africa (Asgisa).
In the article, the authors conducted an econometric analysis of the determinants of the real exchange rate. They found that the global commodity boom explains the rand’s appreciation in the past few years. ”The rand has been a ‘mineral play’ for speculators,” they added. By this, they mean that investors piling into South African assets, especially equities, have bid up the price of the currency.
Frankel et al said that the interest in emerging markets, commodities and commodity-based emerging markets in particular is partially due to easy money flowing from the world’s major central banks. They added that a bubble factor may also explain this investor interest.
The implication of this argument is that a rise in commodity prices pushes up the currency not only because of greater export revenues but also because banks are bidding up the currency as they invest in commodity-based emerging markets.
The significance of the relationship between commodity prices and the real exchange rate is not clear cut. In a draft article, Chen and Rogoff identified South Africa, Chile, Australia, Canada and New Zealand as countries where primary commodities make up a significant component of their exports. Importantly, all of these countries have market-based exchange rates.
Chen and Rogoff found that in these five countries, the world price of their primary commodity exports is an important determinant of their real exchange rates.
But, despite this relationship, the authors find commodity prices are not very helpful in predicting future real exchange rate movements, with the exception of Australia.
In contrast, Cashin et al argued that the relation is useful because it brings an element of predictability regarding exchange rate movements. In particular, they wrote that identifying the relationship between commodity prices and exchange rates will help policymakers in commodity- exporting developing countries develop monetary and exchange rate policies.
This is especially important as countries liberalise their capital markets and make their exchange rate regimes more flexible, they said.
The study by Cashin et al looked at 58 commodity-exporting countries and ran a regression to see whether there was a stable, long-run relationship between a country’s real exchange rate and the real price of its commodity exports.
They found that the relationship existed in 22 of the 58 countries. In these commodity currency countries, more than 80% of the variation in the real exchange rate could be attributed solely to movements in real commodity prices.
This study did not include South Africa in its list of commodity currency countries but neither were Canada and New Zealand, countries that the other papers consider to have commodity currencies.