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Advances in Social Sciences Research Journal – Vol. 8, No. 5
Publication Date: May 25, 2021
DOI:10.14738/assrj.85.10017.
Orach, H., Pu, C., Shen, Q. L., Shiying, W., Ssewajje, H., & Wigmore, R. (2021). Effect of Exchange Rate Volatility on Uganda's Trade
Balance. Advances in Social Sciences Research Journal, 8(5). 532-574.
Services for Science and Education – United Kingdom
Effect of Exchange Rate Volatility on Uganda's Trade Balance
Henry Orach
Sichuan agricultural university
Chengdu, 211 Huimin Road, Wenjian District, 611130, China
Chen Pu
Sichuan agricultural university
Chengdu, 211 Huimin Road, Wenjian District, 611130, China
Qian Ling Shen
Sichuan agricultural university
Chengdu, 211 Huimin Road, Wenjian District, 611130, China
Wei Shiying
Sichuan agricultural university
Chengdu, 211 Huimin Road, Wenjian District, 611130, China
Hassan Ssewajje
Peking University, Beijing, 5 Yiheyuan Rd, Haidian District, 100871, China
Rosie wigmore
Peking University, Beijing, 5 Yiheyuan Rd, Haidian District, 100871, China
ABSTRACT
This study examines the long-run and the short-run relationship between the real
exchange rate, GDP, FDI, inflation (INF), gross capital formation (GCF), Net official's
development assistance (NODA), GNI, and trade balance in Uganda for the period
1994-2018. We used an Augmented Dickey-Fuller (ADF) test for the stationarity
test, and we use the Johannsen cointegration approach to prove the existence of
cointegration. The ADF tests show that the series was non-stationary in level but
became stationary after the first difference. The Johannsen cointegration test
indicates the long and short-run relationship between all the explanatory and trade
balance in Uganda. Under such circumstances, a Vector Error Correction Model
(VECM) is employed since the results offer more information than other data
generation processes. Our findings are as follows: Real exchange rates, FDI, GCF and
GNI have a positive relationship with Trade balance. It means that Uganda can
depreciate the Exchange rate to improve its Trade balance. The results proved the
J-Curve effect's existence (i.e., the long-term impact of exchange rate on trade
balance). The recommendations from this study are - Uganda's monetary policy
management should emphasize more efforts on the stability and minimization of
the volatility of exchange rates of the shillings since its movements affect
international prices both negatively and positively, leading to either a decline or
trade boost.
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533
Orach, H., Pu, C., Shen, Q. L., Shiying, W., Ssewajje, H., & Wigmore, R. (2021). Effect of Exchange Rate Volatility on Uganda's Trade Balance. Advances
in Social Sciences Research Journal, 8(5). 532-574.
URL: http://dx.doi.org/10.14738/assrj.85.10017
Keywords: Trade balance; Real exchange rate; Net official's development assistances;
GNI; VECM model; Uganda
INTRODUCTION
The impact of exchange rate changes has been crucial to the growth of many economies as it
determines their competitive nature in the world market and can either lead to a trade boost
or decline within economies. Exchange rate devaluation will bring the economy back to
equilibrium and act as a positive economic development factor. The real exchange rate is also
an actual relative price that links domestic and international markets for goods and assets. It
also points out the competitive nature of a country's exchange power against the rest of the
world in a pure market [1]. It also determines lots of business, investment, and policy decisions
[2]. As a result, it has attracted lots of attention from various policymakers. However, exchange
rate volatility has been a central defining obstacle to economic growth in most African
economies and Latin American hence have become a severe pressing issue for the government
in the current periods.
Uganda have been suffering from trade deficits over the years, which has dramatically affected
the country's growth and development adversely [3]. As a result, exchange rate policies need
to highly look at as they act as a fundamental tool needed to determine and improve the nation's
trade balance position. Hence, it is a prerequisite to investigate the exchange rate's impact on
Uganda's trade balance. This could help us identify various effective policies that could help
improve the Uganda economy's trade balance.
According to [4], trade balance refers to the value of exported goods minus the value of
imported goods. A positive trade balance signifies a trade surplus, while a negative value
indicates a trade deficit. In 2017, Uganda's trade deficit amounted to around 2.65 billion US
dollars. In a simple term, trade balance refers to the difference between exports and imports
for a given period, usually a year from one country to another.
The exchange rate refers to a foreign currency unit's price in terms of domestic currency [5].
The exchange rate serves as the fundamental link between the local and overseas markets for
various goods, services, and financial assets. With the exchange rate, one can compare the
prices of goods, services, and assets quoted in different currencies. Changes in exchange rates
tend to affect domestic prices of imported goods and services directly. Exchange rate volatility
can affect actual inflation and an expectation about future price volatility [6]. Exchange rate
volatility can also affect the country's external sector through its impact on foreign trade. Lastly,
the exchange rate affects the cost of servicing the country's foreign debt. Under the floating
exchange rates, the foreign currency's value in terms of local currency is determined by demand
and supply forces [7]. the fixed exchange rate refers to the par value rate set between the central
bank's local and foreign currency [8].
[9] shows that the trade balance and exchange rate policy evolution started back in the 1975s
in Uganda. That is when the financial institution held the official exchange rate with the US
dollar close to the initial rate at which the East African Shilling fixed, which the Uganda shilling
inherited in 1966 after the East African currency board's dissolution. The economic
mismanagement of the 1975s and 1980s led to the emergence of a parallel foreign exchange
market [10]. [9] contends that by 1981, the price of foreign currency in the parallel market was
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Advances in Social Sciences Research Journal (ASSRJ) Vol. 8, Issue 5, May-2021
Services for Science and Education – United Kingdom
over ten times higher than the official exchange rate, which limited export trade within the
country, thus inhibiting a negative trade balance. Which later led to an adjustment program to
correct the prevailing exchange rate distortion hence a massive devaluation of the shilling in
July 1982. The policy objective was to eliminate the over-valuation of the Uganda shilling and
establish a unified market-based rate that would provide a uniform price, promoting efficiency
in allocating resources, growth, and development.
In October 1989, a crawling peg was introduced, and as a result, the nominal exchange rate got
adjusted monthly. The foreign exchange bureau implemented the Legalization of the parallel
market through the licensing foreign exchange bureau in 1990, where the bureau was
permitted to conduct spot transactions at freely determined exchange rates and satisfy most
private sector demand for foreign exchange to finance visible and invisible payment [10]. To
address widespread concern about capital flight, creating a market-based foreign exchange
system that aimed to increase the foreign exchange allocation processes' efficiency and
encourage foreign capital flows through open and competitive exchange rate payment systems
was implemented. Whereas exchange rates were market-determined, the foreign exchange
market remained segmented. To eliminate the foreign exchange market's segmented nature
and convergence, the exchange rates, an inter-bank foreign exchange market system, were
introduced in November 1993 [11].
While the traditional theory states that, as the currency depreciates, the trade balance
improves, leading to a rise in net export and a fall in net import, which leads to high aggregate
demand. However, Uganda's trade balance has kept on worsening, whereby import bills have
been growing by an even more significant margin irrespective of continuous currency
devaluation.
Previously, Uganda recorded a trade deficit of 316 USD Million in September of 2020. Balance
of Trade in Uganda averaged -163.81 USD Million from 1993 until 2020, reaching an all-time
high of 14.60 USD Million in April of 1996 and a record low of -483 USD Million in April of 2019.
Figure 1: Uganda Balance of Trade.