Determinants of foreign exchange reserve accumulation: empirical evidence from foreign exchange constrained economy

Abstract

PurposeThe main purpose of this study is to investigate the determinants of foreign exchange reserve accumulation in a foreign exchange constrained economy, namely Ethiopia, over the period of 1981 up to 2017.Design/methodology/approachIn this study, autoregressive distributed lag (ARDL) model is used. Besides, standard unit-root tests such as augmented Dickey Fuller (ADF) and Phillips–Perron (PP) tests are employed to check for the stationarity of the series.FindingsAccording to the results of unit-root tests, our variables are found to be a mixture of I(0) and I(1), and none of our series is I(2). The results of our ARDL model indicates, in the short run, foreign exchange reserve accumulation of Ethiopia is negatively and significantly affected by inflation rate and exchange rate. But, in the long run, inflation rate affects foreign exchange reserve positively and significantly. Additionally, in the long run, external debt affects foreign exchange reserve positively. Similar to its effect in the short run, exchange rate also affects foreign exchange reserve negatively in the long run.Originality/valueThis paper has its originality as it contributes in reasoning out the factors determining, both in the short-run and long-run, foreign exchange deficiency in any developing country with foreign exchange deficiency, taking Ethiopian economy as a case study, and fills the scarce literature on the determinants of foreign exchange reserve accumulation in a developing country.