Ebook Equilibrium Real Exchange Rate and Commodity Prices: The Case of Namibia
Equilibrium real exchange rate is defined as a rate, which is consistent with simultaneous achievement of internal and external equilibrium. Internal equilibrium is a situation where the non-tradable goods market clears, while external equilibrium is achieved when the current account is sustainable. Real exchange rate misalignment is a gap between actual and equilibrium real exchange rate and is a sustained departure of the real exchange rate from its long run equilibrium value (Zhang, 2001, Edwards, 1989a, 1989b and Asfaha and Huda, 2002).
According to Edwards (1988) pointed, the real exchange rate is expected to provide signals to economic agents in the economy. Information on the extent to which the real exchange rate diverges from its equilibrium level serves as a guide to policy makers to ensure that the real exchange rate does not send wrong signals to economic agents. Wrong signals can result in inefficient resource allocation and lead to the reduction of the country’s welfare. Misalignment of the real exchange rate could increase economic instability, distort investment decisions and result in welfare and efficiency costs. According to Edwards (1989a:12) real exchange misalignment especially overvaluation hurts exports and can wipe out the agricultural sector. It can also cause capital flight, which may be optimal from a private perspective but a substantial cost in terms of social welfare.
Despite the fact that the real exchange rate is an important variable in the economy, empirical research on the real effective exchange rate for Namibia is limited. This could be due to the fact that estimating the real exchange rate and real exchange rate misalignment is a challenging task. It requires the determination of the equilibrium real exchange rate in the first place and then measuring the degree of deviation of the actual real exchange rate from this equilibrium value. In recent years, methods for estimating the equilibrium real exchange rate have been advanced by new time series econometrics such as unit roots, cointegration and vector autoregression (VAR).
Namibia is a member of the Common Monetary Area (CMA), together with Lesotho, Swaziland and South Africa. The CMA is an asymmetric currency union dominated by South Africa. Namibia’s currency, the Namibia dollar, is pegged to the South African rand on a one to one basis. Under these conditions, the equilibrium real exchange rate will not only be influenced by Namibian fundamentals, but as well as South Africa’s. Pegged currencies are vulnerable to speculative attacks. It is important to examine trends over time in the indicators of a country’s external competitiveness and balance of payments to assess whether its real exchange rate is likely to be consistent with a sustainable external account.
Devarajan (2001) showed that real exchange rate misalignment in the CFA Franc Zone was disproportionally distributed. Countries whose exports are dominated by primary products experienced the largest real exchange rate misalignments. Estimation of the real exchange rate misalignment is necessary for the CMA. Namibia has a higher share of primary exports in overall exports in comparison to other members of the CMA. It is likely that Namibia experienced some real exchange rate misalignments in response to shocks that affected primary products.
This study is an application of the Johansen (1988, 1995) full information maximum likelihood (FIML) to estimate the equilibrium real exchange rate and the resulting real exchange rate misalignment for Namibia. The study aims to estimate Namibia’s equilibrium real exchange rate from 1970 to 2004. The analysis shows that there is a close and positive relationship between the real exchange rate and commodity prices. Increase in commodity prices causes real exchange rate appreciation. Improvement in technology also causes real exchange rate appreciation. The speed of adjustment is three years. The rest of the paper is organised as follows. Section 2 discusses the theoretical framework; Section 3 discusses the empirical framework; Section 4 presents the results and Section 5 concludes.
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