8. Real Exchange Rate Depreciation Shock and Real Investment Growth: The Balance Sheet Channel

This chapter continues on the exploration of the effects of the real exchange (REER) changes on economic activity. The massive depreciation of the REER since 2011 has spurred neither growth nor exports; hence, we search for evidence whether the real exchange rate depreciation as a measure of competitiveness is the key channel to boost growth via the exports channel. Can the failure of the real exchange rate depreciation shock to stimulate economic growth via the exports channel reflect the dominance of its contractionary effects via real investment growth channel? Evidence in this chapter shows that the beneficial effect of real and nominal depreciation via the exports may be neutralised by the contractionary effects of real depreciation on investment and economic growth. The results further show that investment declines more due to large shocks relative to small exchange rate depreciation shocks. This suggests that investment responds asymmetrically to real rand depreciation shocks. This means that policymakers have to place urgency and more weight on efforts to identify the exchange policy and strategy of dealing with the adverse effects of severe deprecation shocks on investment and economic growth. The exchange rate policy has a direct bearing on both mandates of monetary policy makers. In addition, the exchange rate policy and strategy impact the objectives of the National Development Plan and macroeconomic policy to the extent they prize investment lead growth above exports lead growth. When confronted by the large depreciation in the exchange rate, policymakers need to understand the role of the balance sheet channel and the contractionary effects of large depreciations of investment and growth. These effects far outweigh those of competitiveness and exports growth. The results suggest that the balance sheet channel is a drag on investment following the depreciation shock. Implied in this finding is a serious re-assessment of the exchange rate policy.