Currency harmonisation in the Southern African Development Community: a pathway to addressing the PPP puzzle

Over a century since its inception, the purchasing power parity (PPP) theory, linking exchange rates to relative prices, remains one of the most widely accepted and influential theories in international economics. Despite its theoretical appeal, the empirical validity of PPP remains highly contentious. This study examines the empirical support for PPP within the Southern African Development Community (SADC) region. We employ a battery of linear and ESTAR nonlinear unit root tests, panel stationarity tests, and multivariate cointegration analysis on two distinct numéraire currencies—US dollar and the South African rand (ZAR)—alongside consumer price index (CPI) data for 14 SADC countries over the monthly period 1990:01–2022:04. To this end, we test two important hypotheses in the literature on whether the empirical validity of PPP is influenced by the: (i) ‘numéraire currency’ effect, and (ii) ‘border’ effect. Overall, our findings lend overwhelming support to both of these conjectures. Further evidence suggests that the half-life of parity reversion is significantly shorter for the ZAR-based real exchange rates. These findings imply that SADC meets the optimum currency area (OCA) requirements, making the proposed monetary union a promising prospect.