The impact of exchange rate changes and volatility on trade in Sub-Saharan Africa

Abstract

At a macroeconomic level, deficits as well as surpluses in trade are occasionally attributed to deliberate high or low level of exchange rates. Hence, understanding the influence of exchange rate movements as well as its volatility on trade is therefore of great cognizance to both researchers and policymakers, specifically in this present time of global imbalances. However, previous studies examining these relationships have not been convincing enough regarding the precise impact of exchange rate changes as well as volatility on trade with specific concentration on Sub-Saharan Africa (SSA). Against this backdrop, the main objective of this study is to provide an empirical examination of the impact of exchange rate changes and its volatility from the perspective of imports, exports and trade balance in SSA. The study takes cognizance of the importance and presence of trade blocs in the region. Countries belonging to these trade blocs benefit from certain advantages in terms of their trading activities. In lieu of this, one of the objectives of this study is to provide a comparative analysis of the effects of exchange rate changes and volatility on trade distinguishing four major trading blocs in SSA. These trade blocs include the EAC, CEMAC, ECOW AS and SADC. The two macroeconomic concepts of exchange rate changes and volatility are two distinct concepts which have been empirically misused in the literature. This study therefore provides a thorough econometric analysis distinguishing exchange rate changes and exchange rate volatility impact on trade. This study particularly based itself from empirical literature and theoretical frameworks underpinning exchange rate changes and trade on one hand, and exchange rate volatility and trade on the other hand. In lieu of this, to model exchange rate changes and trade, several variables were chosen to estimate imports, exports and trade balance equations. These variables include domestic income proxy by national GDP, foreign income proxy by USGDP and G7 production index, exchange rate, inflation and money supply. Additionally, to model exchange rate volatility and trade, various measures of volatility were used namely, the standard deviation, GARCH and HP-Filter approaches. The method of analysis used in this study is the panel data analysis which has the advantage of combining both time series and cross-section data. This study uses annual data for 39 countries over the period 1995 to 2012, thus consisting of 702 observations. Eviews 8 was used to analyse the data. Regarding the impact of exchange rate changes and volatility on trade for the entire SSA (Sub-Saharan Africa), the pooled, fixed and random effects model are estimated and based on statistical tests, the most suitable model is chosen. The results of the analysis justified that domestic income, money supply and inflation positively and significantly affect imports in SSA. Though not expected from economic theory, the results indicate that there is a significant positive relationship between exchange rate changes and imports. However, this finding could be attributed to the fact that tl}e vast majority of countries in SSA are still underdeveloped, and therefore tends to depend heavily dependent on imports. As a result, even in an event of a depreciation in their exchange rate, imports are still bound to increase - given the necessity of the produces. In addition, the results maintain that foreign income proxy by USGDP significantly contribute to increase in exports in SSA. However, the production index of advanced economies which also stands as a proxy for foreign income significantly contributes to a iv decrease in exports in SSA. Other variables such as inflation, exchange rate and money supply were also seen to negatively contribute to exports in SSA but were insignificant. The results of the analysis also sustained the theoretical foundation that exchange rate depreciation has a great role to play in increasing trade balance in SSA. The results of the impact of exchange rate volatility on trade in SSA indicate that while some measures indicate a positive relationship with trade, other measures indicate a negative relationship while others are insignificant. Regarding the comparative analysis, the panel cointegration analysis was used, grounded on the fact the results of the unit root test were in favour that the variables are non-stationary. About the impact of exchange rate changes and trade, the results sustained for all trade blocs' domestic income positively contribute to an increase in imports. In addition, it was shown that exchange rate changes do not have a significant impact on imports in ECOW AS. In EAC and SADC, the results justify that exchange rate depreciation has a significant positive impact on imports. The exports model shows that except for CEMAC, exchange rate depreciation has no significant effect on exports. On the other hand, EAC, CEMAC and SADC trade blocs were found to display significant coefficients. While the coefficient for the EAC and SADC display a positive relationship, the coefficient for CEMAC instead displayed a negative relationship. The positive nexus between exchange rate depreciation and imports in EAC and SADC was again ascribed to the high dependence of these countries on imports, as they tend to be very essential for their survival. As a result, even in an event of a depreciation of their exchange rates, imports are still bound increase. In turn, the results of the exports model revealed that except for the ECOWAS trade bloc, there is a statistical significant negative relationship between exchange rate changes and exports. As well as being contrary to economic theory, the study highlighted that these findings may be explained by the fact that the countries' export base are likely to be undiversified and may suffer from poor quality produces. Hence, even in an incident of a depreciation in their exchange rate, if the countries' exports are not solicited by foreign demand, exports are likely to decline. Based on the results of the analysis, the study recommends that policy makers should give attention to strategies that will keep the exchange rate competitive as this will aid in maintaining a positive trade balance. Also, it is recommended that authorities of SSA countries maintain a stable exchange rate environment as it was shown that exchange rate volatility dampen trade. Furthermore, it will important for policy makers to draw up strategies and programmes that will make the economies less reliant on imports. This is of utmost importance because majority of SSA countries are heavily dependent on imports, which leaves them at the mercy on volatile commodity prices. Hence, a depreciation of their exchange rates may have little or no effects in improving their respective balance of payments account, given the ever-increasing level of imports. In turn, following the mixed results encountered for each measure of volatility used, it is suggested that researchers should consider each volatility measure in their respective model estimation. This is particularly important as each measure is really shown to differ; hence, it is important to consider each of them to avoid unreliable results.