Is SADC an optimal currency area? Evidence from the generalized purchasing power parity test

Abstract

In this paper we investigate the likelihood of a proposed monetary union in the Southern African Development Community (SADC) from the viewpoint of the Generalized Purchasing Power Parity (GPPP) hypothesis and optimum currency area (OCA) theory. We apply Johansen's multivariate co-integration technique. The findings from this study confirm that GPPP holds among the 11 SADC countries included in this study on account of cointegration in real exchange rate series. The South African rand-normalized long run beta coefficients of all the real exchange rates are below one except in the case of the Mauritian rupee and all bear negative signs except in the case of the Angolan New Kwanza and Mauritian rupee. This provides some evidence to support monetary union in the region with the exclusion of Angola and Mauritius. However, the absolute magnitudes of the short run adjustment coefficients of SADC countries' real exchange rates are low and bear positive signs in some cases. This finding implies that the observed slow speed of adjustment for (log) real exchange rate of SADC member states might constrain the effectiveness of stabilization policies in the wake of external shocks, rendering SADC countries vulnerable to macroeconomic instability. This result has important policy implications for the proposed monetary union in SADC.