On the Real Exchange Rate Effects of Higher Electricity
Prices in South Africa*
Jan van HeerdenJ James Blignauhand André Jordaan^
September 25, 2008
Abstract
The paper uses a static Computable General Equilibrium (CGE) model of South Africa and
simulates various shocks to the price of electricity. We attempt different closures to the model
and compare their respective effects on the Consumer Price Index. In a CGE model, this is
measuring the real appreciation of the exchange rate, or international trade competitiveness.
In general, we conclude that electricity prices per se does not significantly influence the real
exchange rate, regardless of which closure is used.
JEL codes: D5, E3,H2
1 Introduction
Few would deny the importance of electricity as an essential input to production and to economic
activity in general. Since changes in electricity prices impact every person in South Africa, it is
important to determine the effect on the real exchange rate in South Africa. Salvatore (2004)
defines the real exchange rate as the nominal exchange rate multiplied by the foreign Consumer
Price Index (CPI) divided by the local CPI. In our model, both the nominal exchange rate and
foreign prices are exogenous (and therefore constant, unless shocks occur), so that movements in the
domestic CPI show exactly the inverse of the movements in the real exchange rate. The paper starts
with an overview of electricity prices in South Africa, and concludes with an empirical analysis using
a Computable General Equilibrium (CGE) model.
2 Overview of electricity prices
2.1 International comparisons
Relative to international electricity prices, electricity in South Africa is sold at the second cheapest
rates, beaten only by New Zealand (Doppegieter et al., 1999). This is shown by the fact that the cost
of electricity as a percentage of total cost to company is very low, in most cases less than 5 per cent,
while electricity’s contribution to Gross Domestic Product (GDP) is only approximately 3,5 per
cent. It is therefore not surprising that the demand for electricity is relatively insensitive to changes
*The paper originated from a brief study for the National Electricity Regulator (NER) (later, the National Energy
Regulator of South Africa (NERSA)). The findings of the study showed that higher electricity prices caused very small
inflationary effects. We would hereby like to thank the NER for their financial support and stress that the contents
of the paper do not, in any way, reflect the views of the NER, but only those of the authors. We would also like to
thank Mark Horridge at the Centre of Policy Studies in Melbourne for valuable comments.
^University of Pretoria, [email protected]
^University of Pretoria and Asset Research, [email protected]
^University of Pretoria, [email protected]