The effects of currency devaluation on Ethiopia’s major export commodities: The case of coffee and khat: Evidence from the vector error correction model and the Johansen co-integration test

Abstract

Devaluation of the currency has been stipulated and utilized increasingly as a stabilization device in developing countries. The Ethiopian government employed a devaluation policy to improve the export performance of the country. However, various literature demonstrates that the devaluation of the Ethiopian Birr (ETB) has an ambiguous effect on the country’s export performance. Therefore, the prime objective of the study was to investigate the effect of domestic currency devaluation on Ethiopian major primary export commodities by employing time series data for the period 1987 to 2020. With the help of Johansen’s co-integration and vector error correction modelling, the impact of the devaluation of the real effective exchange rate on major export commodities was assessed in the long run as well as in the short run. The study found that the devaluation of the real effective exchange rate has a positive and significant relationship with the values of major export commodities in the long run. This implies that the decrease in the value of the domestic currency promotes exports in the long run. Other variables like foreign direct investment, with an expected positive sign, and real gross domestic product (with a negative sign), are also found to be statistically significant in explaining exports in the long run. The findings of this paper suggest that policy intervention in the form of devaluing the domestic currency could be effective in improving export performance given that the effect of inflation on output is controlled.