The Effect of Exchange Rate Changes on Trade Balance of Ethiopia: 1970/71 - 2005/06."
No Thumbnail Available
Date
2007-03
Authors
Journal Title
Journal ISSN
Volume Title
Publisher
A.A.U
Abstract
The purpose of this paper is to analyze the effects of change in exchange rate of Birr on
the trade balance of Ethiopia. The study employs the standard Augmented Dickey-Fuller
test in order to test the stationarity of all variables at levels and first differences and the
Johansen and juselius' approach to estimation of multivariate co integration systems on
the quarterly data in the period 1970/ 71QI - 2005/06QI. In order to establish the
existence or absence of a j-curve phenomenon in Ethiopia, we employ impulse response
function to trace the effect of real effective exchange rate on the trade balance of
Ethiopia.
The main findings of the study show that: first, there is a negative relationship between
the trade balance and the real effective exchange rate appreciation indicating that a real
depreciation will improve the trade balance in the long run; second, the results indicate
that there seem to be no clear evidence of the J-curve phenomenon.
The policy implication of the finding is that to improve its international competitiveness
and its trade balance deficit, Ethiopia can use depreciation/devaluation based
adjustment policy. Competitiveness, however, goes beyond currency depreciation. I.e.
currency depreciation alone is unlikely to be able to increase competitiveness.
Therefore, Ethiopia has to use also export diversification strategy i.e. the government
has to pursue to diversify export commodities from agriculture to other products both
vertically and horizontally in order to be competitive and reduce its trade deficit since
most of export items relied on few primary commodities.
The negative sign of domestic real income indicated that a rise in domestic income of
Ethiopia encourages its consumers to demand more foreign goods, leading to a
deterioration of trade balance in favor of its major trading partners. In this regard, the
government has to promote import substitution strategy In order to shift the demand of
domestic consumers towards domestic goods.
Description
Keywords
Exchange rate, trade balance, J-curve