PBA 4802 PORTFOLIO

Table of Contents
Question 1 .................................................................................................................. 1
1.1 Introduction ....................................................................................................... 1
1.2 Impact of a weaker currency on the economy................................................... 2
1.3 Impact of a stronger currency on the economy ................................................. 4
1.4 Conclusion ........................................................................................................ 5
Question 2 .................................................................................................................. 5
2.1 Introduction ....................................................................................................... 5
2.2 Overview of the AfCFTA ................................................................................... 6
2.3 How South African SMMEs can take advantage of the AfCFTA ....................... 6
2.4 AfCFTA challenges to SMMEs .......................................................................... 8
2.5 Conclusion ........................................................................................................ 8
REFERENCES ....................................................................................................... 9

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Question 1

1.1 Introduction

Key macroeconomic indicators are used to reflect a country's economic situation (Reinert,
2020). Inflation is one of the key macroeconomic indicators. In general, the inflation
measures the economy's price stability. In theory, inflation is caused by increases in the
aggregate demand in a country or the increase in cost of production which reduces aggregate
supply. In open economies, inflation is caused by both domestic factors (internal pressure)
and external factors (external pressure) (Achsani, Fauzi & Abdullah, 2018). External causes
include increases in global commodity prices and currency fluctuations. The impact of the
exchange rate on inflation is determined by the country's exchange rate regime.

Reinert (2020) highlight that the exchange rate system plays a vital role in preventing or
decreasing the risk of exchange rate swings having an influence on the economy. Currency
fluctuations in a floating exchange rate regime can have a significant influence on price levels
through aggregate demand and supply (Cooper, 2018). On the aggregate supply side,
depreciation or devaluation of the domestic currency can directly impact the price level
through imported commodities paid for by domestic consumers. This circumstance, however,
obtains if the country is one of the recipients of international pricing (international price taker)
(Cooper, 2018).

Non-direct effects of exchange rate depreciation or devaluation against a country's price level
can be evident in the price of capital goods (intermediate products) imported as inputs in
production. The depreciation of the exchange rate raises the price of inputs, adding to
increased production costs. Producers will almost probably raise the price of products that
customers will pay. Therefore, the country's aggregate price level rises, and if this trend
continues, inflation will occur.

Inflation is inversely related with the purchasing power. As a result of rising inflation, the value
of the domestic currency depreciates. The exchange rate increases as a result. However, all
countries often experience varying rates of inflation. Therefore, the exchange rate is
determined by the comparable rates of inflation. Nations with high inflation rates tend to have
weaker currencies than countries with lower inflation rates (Salvatore, 2016).

Unlike under a fixed exchange rate system, where the exchange rate is set by the central
bank, the exchange rate in a flexible system is determined by a variety of factors. However,
the basic rule is that when demand for foreign exchange outstrips supply, the foreign exchange
rate increases, and when supply exceeds demand, the foreign exchange rate decreases
(Salvatore, 2016). A increase in the exchange rate indicates a depreciation of the country's

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currency, whereas a fall in the exchange rate indicates an appreciation of the currency. There
are several factors that affect the exchange rate, which include the balance of payments
(BOP), the interest rate, inflation, speculation, political stability as well as developments in the
global market environment (Reinert, 2020). This section discusses the exchange rate
valuation, with emphasis on the benefits and costs of depreciation or appreciation of the Rand.

1.2 Impact of a weaker currency on the economy

There appears to be consensus that a weaker currency or depreciation can improve domestic
output by raising the net export component of the aggregate demand (Tafesse, 2019). This is
conceivable because a weaker currency boosts the inter-national competitiveness of domestic
sectors, causing expenditure to shift from foreign to local goods. The following figure provides
a summary of the effects of a weaker currency on the economy.

Figure 1.1: Effects of a weaker currency

Source: Economics Help

A weaker currency makes domestic exports more competitive and seems cheaper to
foreigners. This will raise export demand. For example, the depreciation of the Rand against
the United States (US) dollar results in an increase in South African exports to the US. The
increase in exports improves the net exports component of the aggregate demand, which in
turn improves economic growth. With exports becoming more competitive and imports
becoming more expensive, there should be higher exports and fewer imports, lowering the
current account deficit. In addition, South African assets become more appealing; for example,
a weakened Rand might make South African real estate look cheaper to foreigners.

However, the effect of depreciation on output depends on the elasticity of demand of exports
and imports (Salvatore, 2016). If demand is inelastic, a drop in export prices will result in just

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a minor increase in quantity of exports. As a result, export value may decrease. The Marshall
Lerner condition and the elasticity of demand for exports and imports determine whether the
current account improves on the balance of payments.

The resulting increase in aggregate demand is shown in the following figure.

Figure 1.2: Effects of depreciation on aggregate demand

Source: Reinert (2020)

A weaker Rand can lead to higher economic growth. Because net exports account forms a
component of AD, more exports and lower imports should raise aggregate demand, assuming
that demand is relatively elastic). Higher AD is expected to result in higher real Gross
Domestic Product (GDP) and inflation, holding other factors constant. This however depends
on the state of the global economy. If the world economy is in a recession, a weaker Rand
may not be enough to improve export demand. If global economic growth is high, demand will
rise more rapidly. In a boom, however, a weaker Rand is likely to worsen inflation.

However, a weaker currency is likely to increase domestic inflation (Yilkal, 2014). Imports such
as petrol, food, and raw materials become more costly as the Rand weakens. This will raise
the domestic cost of production, thus fuelling inflation. The result is cost-push inflation. A
weaker Rand coupled with events in the global environment, such as the Russia-Ukraine
conflict further drives up domestic inflation. The conflict has immediately resulted in higher oil

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and grain costs, which in turn have raised the prices of important consumer price index
(CPI) goods like as petrol and bread. Very high commodity prices can also have second-order
inflationary impacts, such as raising public transportation or food prices to offset businesses'
higher fuel costs.

Further, a weaker Rand has negative implications for wages of foreign nationals working in
South Africa. A falling Rand makes South Africa less appealing to foreign workers. Migrant
workers, for example, may opt not to work in South Africa if the value of the Rand falls. To
retain foreign labour, South African businesses may have to raise salaries. Similarly, it
becomes more appealing for South African workers to work in the United States since a dollar
pay goes further. In addition, a weaker Rand reduces domestic real wages. A weaker Rand
might induce a reduction in real wages during a time of stagnant wage growth. This is because
depreciation of the Rand produces inflation, but if inflation exceeds wage growth, real wages
decrease (Cooper, 2018)

Empirical evidence has mixed results on the long-term effects of a weaker currency. However,
there seem to be consensus that a weaker currency has long term positive implications on the
economy. Yilkal (2014) found that a weaker domestic currency decreases real GDP in the
short run but increases real GDP in the long run in the case of developing countries. Tafesse
(2019) found that a weaker currency has contractionary effects in the short term but it has
expansionary effects in the long run. The different results of currency depreciation in different
nations are explained by the countries’ economic structures.

1.3 Impact of a stronger currency on the economy

According to Reinert (2020), long-term exchange rate appreciation is generally an indication

Appreciation of the Rand would also assist to keep inflation low and import prices low. This
would raise domestic living standards since South Africans would be able to import products
at a cheaper price. Salvatore (2016) submits that what matters is that a strong currency is
beneficial if it results from increased competitiveness.

However, if the value of a currency rises due to speculation, the increase in the currency's
value may be improper and generate an imbalance in domestic demand (Cooper, 2018).

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Imports will increase as they become cheaper, and this widens the current account deficit and
reduces net exports. Holding all other factors constant, this results in economic contraction.

1.4 Conclusion

Based on the analysis, despite theoretical arguments that a weaker currency improves
economic growth, the costs of having a weaker currency outweigh the benefits. Weaker
currencies cause inflation and reduces standards of living in the long term. Therefore, it is
beneficial for South Africa to have a strong Rand. Foreign investment costs less when the
Rand is strong. when the currency is strong, acquisitions are less expensive. The purchasing
power for products s priced in weaker currencies improves when the currency is strong.
Furthermore, a strong Rand lowers the cost of commodities such as gas and oil imports.
Countries with strong currencies, such as the United States, prefer to purchase oil reserves
elsewhere rather than boost domestic supply.

Question 2

2.1 Introduction

The World Bank (2021) notes that small, medium, and micro enterprises (SMMEs) account
for 90% of all businesses and employ at least 50% of the global workforce. Formal small
enterprises provide a major contribution to GDP. Further, when the informal economy is
included, its contribution to GDP is significantly increases. As a result, SMMEs play a critical
role in the growth of African economies.

In South Africa, SMMEs employ over 60% of the workforce. To address the country's
youth unemployment, the government has highlighted SMEs as the way ahead for creating
employment and stimulating economic growth (World Bank, 2021). Even though SMEs play
an important role in economic growth, it should be emphasised that the failure rate of SMEs
is exceptionally high due to a variety of challenges in the domestic market. South Africa
currently faces several challenges including energy crisis. The country has been experiencing
electricity crisis in recent times and this has had an impact of small businesses across the
country. Given these challenges facing South Africa, and the recent economic progress of
other African countries such as Zambia, in the context of global business, SMMEs in South
Africa can take advantage of the African Continental Free Trade Area agreement (AfCFTA) to
explore business opportunities across the continent. This section focuses on discussing some
of the ways South African SMMEs can take advantage of the free trade agreement.

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2.2 Overview of the AfCFTA

The AfCFTA is the world's biggest single market after the World Trade Organization (WTO) in
terms of member countries. The AfCFTA agreement went into effect in January 2021, and it
is estimated to generate a combined GDP of around 3.4 trillion US dollars for Africa (Draper,
Edjigu & Freytag, 2022). The AfCFTA unites over 1.3 billion people across 54 African nations,
resulting in unparalleled economic integration. African nations will benefit from tariff reductions
through the AfCFTA. Besides lower tariffs, member states will gain from trade facilitation as
well as favourable regulatory initiatives that will raise standards.

The full implementation of the AfCFTA implies the elimination of tariffs on up to 90% of goods
over a five-year period. Prior to the signing of the world's largest free trade agreement, intra-
African exports accounted for 16.6% of overall exports in 2019 (Ajambo & Emebinah, 2021).
In comparison, Europe achieved a stunning 68.1%, while 59.4% of Asian nations traded
among themselves and 55% of American countries traded inside their continent (Draper et al.,
2022). That is why the AfCFTA is crucial for Africa in order to enhance intra-African trade.

The AfCFTA is also intended to facilitate labour mobility. However, due to varied degrees of
development as well as human resource capability, that is the number of skilled workers in a
given nation, several African states are opposed to free movement of people.

2.3 How South African SMMEs can take advantage of the AfCFTA

Any economic policy that enables imports and exports within member nations - with reduced
or no tariffs, unfettered market access and market information, and the removal of trade
restrictions - provides several benefits to SMEs. The following are some of the AfCTA
advantages that South African SMMEs can utilise.

Increased access to new markets

The AfCFTA will help South African-owned businesses to expand into new markets. This
increases their customer base and contributes to new goods and services, allowing them to
invest in innovation. With AfCFTA, South African SMMEs now have access to a larger market
in the shape of the continent's billions of people, rather than only domestic market exposure.
Furthermore, because the trade agreement removes country-specific restrictions, technology
transfer becomes possible (Ajambo & Emebinah, 2021). For example, with Zambia realising
positive economic progress and South Africa experiencing energy crisis, AfCTA allows South
African SMMEs to consider expanding business operations into Zambia and enjoy a wide
customer base. AfCTA's effective implementation offers the ability to expand product and
service options among SMMEs in various nations.

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The AfCFTA also enables SMMEs to export to African countries that are realising economic
growth and per capita income growth. Growth of income in other African countries increase
South Africa exports as foreigners have more money to spend on South African products.

Improved capabilities in manufacturing

South African SMMEs in the manufacturing sector can take advantage of improved capabilities
in manufacturing because of the AfCFTA. As a direct outcome of expanded markets, SMMEs'
production capacity will improve. This, in turn, will drive the economic growth of AfCTA
member nations, resulting in better business for SMMEs. As a result of this progress, better,
more meaningful work options will become available, resulting in a greater middle-class
(Abrego, de Zamaroczy & Gursoy, 2020). Therefore, the AfCFTA could have a snowball effect,
assuring continued capacity-building for the continent's small enterprises.

Investment opportunities

The AfCFTA opens investment opportunities for African firms. The removal of trade barriers
may also have the impact of simplifying bureaucracy and making doing business easier. This
has the potential to draw increased levels of investment, both domestic and international, into
important industrial areas, propelling the productivity cycle onward (Abrego et al., 2020). This,
in turn, will increase lending, allowing small enterprises to get better access to credit and
capital.

The AfCTA creates efficiency in supply side

Given the challenges facing South Africa, South African SMMEs may struggles to purchase
raw material domestically, and this affects the supply side of the small businesses. The
AfCFTA provides SMMEs with more efficient access to raw materials from other nations at
possibly lower prices. Import tariffs as well as customs duties imposed at the domestic level
by governments are one of the causes for the high prices of raw materials. Removal of these
tariffs results in supply-side efficiencies, which will translate to enhanced production
processes and profitability (Oramah, 2021).

Improvement in technology

South Africa faces challenges in the telecommunications sector and this may affect local
SMMEs. With AfCTA, South African SMMEs can benefit from improvement in technology.
Technological enablers such as information and communication technology (ICT) and fintech-
based payment systems are required to allow effective cross-border trade throughout the
continent. The rising availability of these technologies has a direct influence on access to
financial services on the African continent and improves financial inclusion. This may create

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additional prospects for the growth of SMME start-ups in the technology sector. Disruptive
technologies tend to promote comparable ideas in multiple domains (Draper et al., 2022). This
would imply an all-encompassing shift toward technological advancements that would improve
the prospects of small firms.

2.4 AfCFTA challenges to SMMEs

Despite presenting growth opportunities for SMMEs, the AfCFTA poses some threats to
SMMEs survival. The AfCFTA may have a substantial impact on SMEs in Africa's smaller
economic regions. There is a prospect that SMMEs currently operating in larger economies
would gain speedier market access by capitalising on their established efficiencies and scale
economies. This may push smaller SMEs out of the market.

Further, opening the African continental market may result in problems like intellectual
property theft, for which many African governments are unprepared. Furthermore, the high
bureaucracy levels and conformism in most African countries may prevent SMMEs from
seeking quick resolution of issues as they emerge.

2.5 Conclusion

The AfCFTA represents a huge potential for South African SMMEs to benefit from increasing
integration. Protectionism limits African SMMEs to low-income prospects and creates
significant bottlenecks within their respective nations. As a result, AfCFTA must consider
policies that encourage small enterprises to attain accelerated economic growth while
preserving livelihoods. The continent's economic intricacies may provide a barrier to the
success of the AfCFTA, negatively impacting SMMEs. However, members to the pact must
focus on preparing local SMMEs to take advantage of the free trade agreement. Furthermore,
to minimise the collapse of small businesses, trade agreements must consider fair competition
regulations.

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REFERENCES

Abrego, M.L., de Zamaroczy, M.M., Gursoy, T., Nicholls, G.P., Perez-Saiz, H. and Rosas,
J.N., 2020. The African Continental Free Trade Area: Potential Economic Impact and
Challenges. International Monetary Fund.

Achsani, N.A., Fauzi, A.J.F.A. and Abdullah, P., 2018. The relationship between inflation and
real exchange rate: comparative study between Asean+ 3, the EU and North
America. European Journal of Economics, Finance and Administrative Sciences, 18(18),
pp.69-76.

Ajambo, E. and Emebinah, C., 2021. The African Continental Free Trade Area (AfCFTA):
Maximizing Benefits for the Continent. Harvard Africa Policy Journal.

Cooper, R.N., 2018. An Analysis of Currency Devaluation in Developing Countries 1.

Draper, P., Edjigu, H. and Freytag, A., 2022. A Political Economy Assessment of the AfCFTA.
In The Palgrave Handbook of Africa’s Economic Sectors (pp. 693-719). Palgrave Macmillan,
Cham.

Oramah, B., 2021. Afreximbank in the Era of the AfCFTA. Journal of African Trade.

Reinert, K.A., 2020. An introduction to international economics. Cambridge University Press.

Salvatore, D., 2016. International economics. John Wiley & Sons.

Tafesse, B., 2019. The Impact of Currency Devaluation on Economic Growth: Its Benefits And
Costs on Ethiopian Economy (Doctoral dissertation, st. mary's University).

World Bank, 2021. World Bank Group Support for Small and Medium Enterprises (SMEs).
Available at: https://ieg.worldbankgroup.org/evaluations/world-bank-group-support-small-
and-medium-enterprises-smes (Accessed: 17 October 2022).

Yilkal, W.A., 2014. The effect of currency devaluation on output: The case of Ethiopian
economy. Journal of Economics and International Finance, 6(5), pp.103-111.