The Effect of Domestic Currency Devaluation on Trade Balance in Ethiopia

Weldearegawi Sahle Berhe

doi:10.7176/rjfa/11-1-03

Abstract

The prime objective of the study was to investigate the effect of domestic currency devaluation on trade balance in Ethiopian over the period 1974-2016. To address the objective, ARDL and Error Correction Model were applied. The ARDL bound test result shown that There is a long run relationship between real effective exchange rate, real domestic income and lending interest rate .Specifically, real effective exchange rate, real domestic income and lending interest rate have a significant and positive effect on trade balance; whereas money supply and government expenditure deteriorated trade balance while deposit interest rate was insignificant in the long run. This clearly shows that both elasticity and absorption approaches improved the trade balance but monetary measures have deteriorated it. Hence; the government should take follow contractionary monetary policy and absorption approach through productivity improvement, diversification of export sectors and expansion of import computing industries to overcome trade deficit. Keywords: Ethiopia, Trade Balance, Currency Devaluation, ARDL Bound test. DOI : 10.7176/RJFA/11-1-03 Publication date: January 31 st 2020

Highlights

Our world faces insufficient match between limited resource and unlimited human wants
The main finding of this paper is that in the long run birr devaluation has improved the trade balance by 0.5288 percent when birr is devaluated by 1 percent against US dollar but in the short run it deteriorated trade balance in which 1 percent birr devaluation brought 0.6597 and 0.5142 percent decreased in trade balance at the immediate two years after devaluation and improves over time
While money supply and government expenditure are negatively affected trade balance during the study period which deteriorated by 5.54 and 1.33 percent for 1 percent of a percentage increase respectively as well as percentage increase of lending interest rate has contributed on trade balance improvement

Summary

Introduction

Our world faces insufficient match between limited resource and unlimited human wants. To solve this mismatch, many countries are trading their production in international market by determining their currency value with respect to US dollar. Many countries are trading their production in international market by determining their currency value with respect to US dollar This international trade critically affected by exchange rate system and developing countries are vulnerable to this system (Kibret, 1994). The exchange rate affects trade balance through its effects on competitiveness; the appreciation of domestic currency increases cost of production and the country decreases its competitiveness in the global market and this leads to trade deficit (Morck et al, 2000). Under the structural adjustment program with the support of international monetary fund and World Bank during 1992/93 the Ethiopian birr was devaluated from 2.07 birr to 5 birr per US dollar and its devaluation was continuously reached about 27.41 in 2017 with objective of balancing external sector in general and improving account balance and boost exports and to stay competitive on price (NBE, 2018)

Objectives

Methods

Findings

Discussion

Conclusion