Some thoughts on the South African economy

Currently I’m vacationing in South Africa on the Indian Ocean side of the tip of Africa at a place called St. Francis Bay, which is near to Humansdorp, which in turn is west of Port Elizabeth. It’s a place I know quite well as I’ve been coming here now for years – my first visit being back in 1982 if you can believe it. South Africa, is a commodity-rich country with an extremely diverse population and a troubled past, although it is by far the most successful African country and has experienced a massive influx of workers in recent years.


Apart from the great weather and generally friendly people you encounter here, I usually pick up some interesting gifts at great prices, and often end up spending more money than I’d usually like, partially as prices here are so reasonable. Labor here is plentiful and this leads to low costs for goods and services produced in this country or imported from neighboring countries.

But this visit things are different. For the first time when I convert prices in South African Rands (SAR) into US dollars I’m finding that prices are at or above what I’d pay for comparable items in the US. Interestingly the Europeans I’ve run into are finding exactly the same, so the implication is that the Rand is out of line with what economists call the purchasing power parity.

(You can skip this next paragraph if you’re an economist).

So what is purchasing power parity or PPP? It is the idea ( - and probably the oldest idea in economics), that (identical) goods or services should cost the same wherever you buy them. When you use the same currency it’s called the “law of one price” as you’d expect the same item to have identical cost whether you buy it in Jo’burg or Cape Town. Obviously there are small variations in price within a country, but by and large, the “law” holds. When comparing things internationally you obviously have to use the exchange rate, which means that you convert the price in US$ by the current exchange rate into SAR and then compare it with what the price is in South Africa. If prices are generally higher in South Africa we’d say that the Rand is “overvalued” compared to PPP, and conversely if prices are generally lower in South Africa the Rand would be “undervalued”.

At any rate, it is clear to me that the Rand is definitely “overvalued” compared to what it’s been on my previous trips out here. That does not encourage me and other visitors to spend and will likely mean that tourist revenues from spending will be quite a bit lower this season than they were last season. It also means that South African exports of goods and services will likely be falling in value as well, as foreign importers decide to source the products they were buying from South Africa from somewhere else – China for example!

This beggars another question though - why is the Rand so strong? The answer most commentators will give is that South Africa is a commodity-exporting country, and that commodity prices are high right now as we are beginning to come out of the global recession and demand for these products is beginning to outstrip supply.

Given the rate of inflation that South Africa has compared to say the US dollar, the Rand should have been losing value, not holding roughly constant over the past year. Given this “inflation differential” continues into the future, the Rand will likely suddenly lose value at some point in the next 6 months or so, given that the foreign exchange market starts to divert its attention back to other issues other than recovery from the global recession! I’m wondering whether this will happen before or after the FIFA World Cup happens here…I would suspect after…

But more on that next time….in the meantime the beach is calling!!