Modelling the impacts of macro-economic policies on the South African agricultural sector

Abstract

This study analyses the importance of macro-economic policies and other macro-economic variables on South African agricultural performance. Following the liberalization of the South African economy, the democratisation of the political environment, and the deregulation of the agricultural sector, macro-economic policies and variables have had a much more direct effect on the financial position of the agricultural sector. In the absence of government intervention, agricultural output prices are determined in the international market, and this may lead to uncertainty in the prices received by farmers for agricultural products. Macro-economic policies that are thought to influence agricultural performance include monetary, fiscal, exchange rate and trade policies. These macro-economic policies are represented by government expenditure, money supply, real exchange rate, gross domestic product, and degree of openness. The study applies an equilibrium exchange rate and error correction model methodology to estimate exchange rate misalignment, and further extends the model to measure the impacts of exchange rate and other macroeconomic variables on the relative agricultural prices. Quarterly data between January 1988 and April 2002 are used in the estimation. The model is estimated using the Eviews statistical package. The results show that terms of trade and government expenditure are positively related to the real exchange rate. A one percent increase in terms of trade will lead to 0.729 percent appreciation in the exchange rate in the long run. The degree of openness of the economy is also positively related to the real exchange rate (RER), and the RER appreciates by 0.555 percent in response to a 1 percent increase in the degree of openness. The technological and productivity improvement variable was found to be statistically insignificant. The speed of adjustment of the real exchange rate towards equilibrium is slow, namely, 17 percent. The results of the equilibrium exchange rate indicate that the exchange rate was overvalued between 1989 and 1998, while between 2001 and 2002 the exchange rate was undervalued. The results also indicate that the relative agriculture prices are negatively affected by the appreciation of the effective exchange rate. A one percent increase in the actual real exchange rate leads to a 0.34 percent decline in the relative prices of agriculture. The degree of openness in the South African economy and the gross domestic product (GDP) were found to be insignificant. Most importantly, a one percent rise in money supply is associated with a 1.189 percent decline in the relative prices of agriculture in the long run. This implies that an increase in the real exchange rate and in money supply lead to a reduction of the relative prices of agriculture. The speed of adjustment of the relative prices of agriculture towards equilibrium is fairly fast at more than 0.36. An increase in money supply and real exchange rate will result in lower agricultural prices in South Africa, thereby reducing the profitability of farms. The degree of openness and income does not appear to have any effect on the prices. This implies that the integration of the South African economy into world markets will not significantly affect domestic farmers.