The effect of exchange rate volatility and selected macroeconomic variables on Intra-East Africa Community Regional Trade

Abstract

Exchange rate is the charge of one nation’s currency in terms of another nation’s currency, how rapidly the exchange rate fluctuates is termed as volatility. In East Africa Community exchange rate volatility went up when the countries adopted the structural Adjustment Policies in the early 1980s. The question that remain unanswered is that of knowing whether exchange rate volatility hinders or promote trade. The specific objectives of the study were to determine the volatility of exchange rate, examine the effects of exchange rate, analyze the effects of money supply, determine the effects of inflation, examine the effects of population and evaluate the effects of foreign direct investment on Intra-East Africa community regional trade. The theory that guided the study is the traditional, risk-portfolio and political economy theories. Longitudinal research design was adopted in this research. The study used yearly panel data ranging from 2000-2017. The data for this study was sourced from World Bank, Food and Agricultural Organization (FAO) and World Integrated Trade Statistics (WITS). The Generalized Autoregressive Conditional Heteroscedasticity (GARCH) model and fixed effect model were used in the study. To fix the collected data into these models, panel unit root tests were conducted to check for stationarity of the data. Unit root test results indicated that some of the variables were stationary at levels and upon the first differencing all variables were integrated of order one I (1) hence stationary. The first differenced panel data were then fitted into the GARCH model to measure volatility. The same first differenced panel data were also fitted into the fixed effect model which was shown by the Hausman test results to be more robust in testing the hypotheses. The arch/garch model results indicates significant positive volatility (β 0 = 1.0908, p= 0.000). The results from the fixed effect model showed that exchange rate (β 1 = -0.0008, p= 0.000), money supply (β 2 = 2.9468, p= 0.000), population (β 3 = 2.6362, p= 0.000) and foreign direct investment (β 4 = 0.2018, p= 0.000) significantly determines intra-EAC regional trade. Inflation was however found not to be significant (β 5 = -0.0010, p= 0.312) at 95% level. The study concluded that exchange rate volatility exists in the Intra-East Africa region. In addition, it was also concluded that exchange rate, money supply, population, and foreign direct investment have an influence on intra-EAC regional trade. The study recommends that EAC member states should formulate policies that ensures exchange rate stability in the region to ensure reduced volatility and unpredictable exchange rate. In addition, policies should also be put in place that guarantees sufficient money supply and encourages foreign direct investments.