Do Oil Price Shocks Affect Exchange Rates in Oil-importing Countries: A Case of the Zambian Economy using the SVAR Approach

Abstract

Oil price shocks have been argued to impact Real Effective Exchange Rates (REERs) in net oil importing countries, mostly through the wealth-transfer effect, which involves the transfer of wealth from net oil-importers to net oil-exporters, and the Terms of Trade Channel. Since this analysis had not been done for the Zambian case by decomposing oil price shocks, a Structural Vector Autoregressive Model (SVAR) was used to measure the contemporaneous impact of oil price shocks on REERs, and was complemented by Impulse Response Functions (IRFs), Granger Causality Tests and Forecast Error Variance Decomposition (FEVD). The long-run impact was analyzed by the Vector Error Correction Model (VECM) after satisfaction of cointegration requirements. The findings revealed that decomposed oil price shocks had no short-run contemporaneous impact on REERs at the 5% level. Similarly, it was found that decomposed oil price shocks and the combined effect of all the variables in the system did not granger-cause Zambia’s REERs, while FEVD results showed that oil price shocks were attributed for a minute proportion of the variation in REERs. These findings were attributed to Zambia’s profile as a predominantly copper and cobalt exporter, historic exchange rate controls, fuel subsidies, and price controls. Johansen’s cointegration test revealed the existence of at least one cointegrated equation in the system, so the subsequent VECM which was constructed revealed that decomposed oil price shocks had no long-run impact on REERs in Zambia, but that the Error Correction Term (ECT) which measures the speed to adjustment back to equilibrium after a short-run disturbance, was significant.