Effect of Exchange Rate Misalignment on Bilateral Trade Between Kenya and European Union: 2000-2016
Keywords:
Misalignment, trade flows, exports, imports
Abstract
The exchange rate is an important variable in international trade because a country's competitiveness is determined by the expectations on how trade reacts to its movements. To orient the economy outwards, Kenya has pursued various measures from the 1990s to the 2000s. Kenya also signed up for nonreciprocal trade with the European Union under the Cotonou agreement. Despite the export-oriented efforts, Kenya's trade has remained skewed towards imports and a widening trade deficit which seems to follow the weakening of the Kenya shilling. The main policy dilemma therefore, is how imports accelerated in an environment of unhindered European Union market access, hence the motivation of this study. The study adopted a dynamic modeling approach since previous and present values affect exchange rate and trade. The results show that the economic fundamentals drive the real exchange rate. In terms of misalignment, the exchange rate is overvalued to a maximum of 5.9 percent and undervalued up to 5.2 percent. The estimated misalignment hurts imports but has a positive, statistically insignificant effect on exports. The results of this study suggest that the monetary authority should ensure the exchange rate remains stable and within the 6 percent range while monitoring all the underlying determinants. Additionally, hedging instruments should be made available and affordable to traders.
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References
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3. Balassa, B., (1964). The Purchasing-Power Parity Doctrine: A Reappraisal. Journal of Political Economy Vol. 72, No. 6 (Dec., 1964), pp. 584-596.
4. Barno, A., Ondaji, B., & Ngwiri, J. (2011). Dynamics of horticultural export to European Union market: Challenges and opportunities in Sub-Saharan Africa. Acta orticulturae 911(911):61-72.
5. Bird, G. (1998). Exchange Rate Policy in Developing Countries: What Is Left of the Nominal Anchor Approach? Taylor & Francis, Ltd. Third World Quarterly, No. 2 (19) (Jun., 1998), pp. 255-276.
6. Calamitsis, E., Basu, A., & Ghura, D. (1999). "Adjustment and Growth in Sub-Saharan Africa." IMF Working Paper Series 99/51. Washington, DC: International Monetary Fund.
7. Calderon, C. A., Chong, A., & Loayza, N. (2002). "Determinants of current account deficits in developing countries." The B.E. Journal of Macroeconomics 2, no. 1: 1–31.
8. Cote, A. (1994). Exchange rate volatility and trade A survey. Bank of Canada Working Paper 94-5.
9. Csermely, A. (1994). The Impact of Exchange-Rate Policy on the Development of Industrial Competitiveness. Russian & East European Finance and Trade, Vol. 30(6), pp. 6-27.
10. Dornbusch, R. (1976). Expectations and Exchange Rate Dynamics. Journal of political Economy. 84 (6), 1161-1176.
11. Edwards, S. (1989). "Exchange Rate Misalignment in Developing Countries," UCLA Economics Working Papers 442, UCLA, Department of Economics.
12. Edwards, S. (1997). The Mexican Peso Crisis: How Much Did We Know? When Did We Know It? National Bureau of Economic Research. Working Paper 6334.
13. Ekanayake, E. M., Thaver, R. L., & Plante, D. (2012). The effects of exchange rate volatility on South Africa's trade with the European Union, The International Journal of Business and Finance Research, 6(3), 13–26.
14. Gaalya, M. S. Edward, B., & Eria, H. (2017). Trade Openness and Dissagregated Import Demand in East African Countries. Scientific Research Publishing, 2017 (8) 667-689.
15. Ibrahim, W. (2014). Real Exchange Misalignment and Trade Flows in Nigeria (1960-2013). Journal of Academic Research in Economics, Vol 6 (3).
16. Imbs, J., & Isabelle M. (2011). "Trade Elasticities," August 2011, mimeo, Paris School of Economics and Ecole Polytechnique.
17. Juthathip, J. (2009). Equilibrium Real Exchange Rate, Misalignment, and Export Performance in Developing Asia. Asian Development Bank, Working Papers 151.
18. Kiptui, M. C., & Kipyegon, L. (2008). External Shocks and Real Exchange Rate Movements in Kenya. The 13th Annual Conference on Econometric Modelling in Africa 9-11 July 2008: University of Pretoria.
19. Kiptui, M.C., & Ndirangu, L. (2015). Determinants of Equilibrium Real Exchange Rate and its Misalignment in Kenya: A Behavioral Equilibrium Exchange Rate Approach, MPRA Paper No. 70542, https://mpra.ub.uni-muenchen.de/70542/
20. Lugaiyamu, L. (2015). Determinants of Exchange Rate in Tanzania. (unpublished). Uppsala University.
21. Manni, U. H., & Afzal M. N. I. (2012). Effects of Trade Liberarization on Economic Growth of Developing Countries: A case of Bangladesh Economy. Journal of Business, Economics and Finance Vol 1(2).
22. Musyoki, D., Pokhariyal G. P., & Pundo, M. (2012). Real Exchange Rate Equilibrium and Misalignment in Kenya. Journal of Business Studies Quarterly, Vol 3, No, 4, 24-42.
23. Mukherjee, D., & Pozo, S. (2007). Exchange-Rate Volatility and Trade: A Semiparametric Approach. Applied Economics. Vol 43, (13).
24. Mwangi, S. C., Mbatia, O. L. E., & Nzuma, J. M. (2014). Effects of Exchange Rate Volatility on French Beans Exports in Kenya. Journal of Agricultural Economics, Extension and Rural Development, 1(1), 1–12.
25. Mwega, F., M. (2014). Real Exchange Rate Misalignment and Implications for the Nominal Exchange Rate Level in Kenya in 2012. Central Bank of Kenya.
26. Naseem, N. A. M, Tan, H., & Hamizah, M.S. (2009). Exchange Rate Misalignment, Volatility and Import Flows in Malaysia. International Journal of Economics and Management 3(1): 130 – 150
27. Nkalu, N., Urama, N.E., & Asogwa, F. (2016). Trade openness and Exchange Rate Fluctuations Nexus in Nigeria. European Journal of Scientific Research vol 138 (3), 139
28. Nkoro, E., & Uko, A. (2016). Auto Regressive Distributed Lag (ARDL) Cointegration Technique: Application and Interpretation. Journal of Statistical and Econometric Methods Vol 5 (4) 63-91.
29. Oiro, M. O. (2015). Real Exchange Rate Volatility and Exports in Kenya: 2005-2012. Journal of World Economic Research. Vol. 4, No. 5, 2015, pp. 115-131.
30. Olimov, U., & Sirajiddinov, N. (2008). The Effects of the Real Exchange Rate Volatility and Misalignment on Foreign Trade Flows in Uzbekistan. Discusion Paper 2008-29, Center for Economic Research, Tushkent, Uzbekistan.
31. Pesaran, M. H., Shin, Y. & Smith, R. J. (2001). Samuelson Bounds Testing Approaches to the Analysis of Level Relationships; Journal of Applied Econometrics, Vol. 16, 2001, pp. 289–326.
32. Republic of Kenya. (2004). Economic survey. Nairobi: Government printer.
33. Republic of Kenya. (2007). Economic survey. Nairobi: Government printer.
34. Republic of Kenya. (2012). Economic survey. Nairobi: Government printer.
35. Republic of Kenya. (2014). Economic survey. Nairobi: Government printer.
36. Republic of Kenya. (2015). Economic survey. Nairobi: Government printer.
37. Republic of Kenya. (2017). Economic survey. Nairobi: Government printer.
38. Republic of Kenya. (2019). Economic survey. Nairobi: Government printer.
39. Sidek, N.Z. (2011). Malaysia: How Much Exchange Misalignment is Detrimental to Exports?. International Conference in Economics, Trade and Development. IPEDR Vol 7.
40. Siregar, R. Y. (2011). The Concepts of Equilibrium Exchange Rate: A Survey of Literature. The South East Asian Central Banks (SEACEN). Kuala Lumpur, Malaysia.
41. Sultan, Z.A. (2011). Foreign Exchange Reserves and India's Imports Demand. A Cointegration and Vector Error Correction Analysis. International Journal of Business and Management Vol 6 (7).
42. World Bank. (2012). Can Real Exchange Rates Undervaluation Boost Exports and Growth in Developing Countries? Yes, but not for Long. Poverty Reduction and Economic Management Network (PREM). World Bank. Washington. Issue 10.
Published
2021-12-31
How to Cite
Gachoki, C. M., Okeri, S., & Korir, J. (2021). Effect of Exchange Rate Misalignment on Bilateral Trade Between Kenya and European Union: 2000-2016. European Scientific Journal, ESJ, 17(41), 58. https://doi.org/10.19044/esj.2021.v17n41p58
Section
ESJ Social Sciences
Copyright (c) 2021 Charles Munene Gachoki, Susan Okeri, Julius Korir
This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.
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