Assessing the Effects of Exchange Rate Volatility on Zambia’s Economic Growth: Evidence from ARDL and NARDL Models

Abstract

This study investigated the interplay between exchange rate volatility, inflation rates, and real interest rates on Zambia’s economic growth from 1992 to 2022, utilizing annualized time series data. The study was necessitated by the limited published literature and relatively varying findings on the variables’ relationships in resource-dependent countries, such as Zambia. Diagnostic tests, including stationarity and co-integration analyses, were employed to determine integration orders and potential long-run relationships. The linear and nonlinear autoregressive distributed lag models were employed to assess short- and long-run dynamics of the variables on economic growth. The results established a positive short-run relationship between inflation rates and Gross Domestic Product (GDP) growth in the linear autoregressive distributive lag model, while an inverse relationship was observed in the nonlinear autoregressive distributive lag model, suggesting that negative shocks in inflation rates had a highly significant positive impact on economic growth. Furthermore, interest rates exhibited a positive relationship with economic growth, further suggesting that positive shocks had a greater significant direct effect on economic growth in comparison to negative shocks in the short and long run, respectively. Finally, exchange rates in both models exhibited an inverse relationship with economic growth irrespective of positive or negative shocks in the long run, highlighting the adverse effect of exchange rate volatility on economic growth prospects in developing countries, such as Zambia. The speed of adjustment to convergence following any disruptions was determined to be 75.18% (ARDL) and 89.19% (NARDL), highlighting relatively fast speeds of adjustments from any short-run disruptions. Notably, some of the policy recommendations included regular assessments of exchange rate volatility influences on import prices, domestic inflation, and production costs in key sectors. Additionally, the implementation of currency hedging options and forwards as well as bulking of foreign exchange reserves will ensure the stability of exchange rates against other major currencies in various economic conditions.