Impact of Exchange Rate on Ethiopian Trade Balance: Evidence from ARDL Model

Abstract

The government of Ethiopia has persistently devaluated its currency in which few studies attempted to examine the effect on the country’s trade balance. Hence, this study examined the nexus between the real exchange rate and the trade balance of Ethiopia in the period between 1998 and 2020. The study employed the absorption, elasticity, and monetary approaches as a theoretical framework and the autoregressive distributed lag model as an analytical model. As descriptive analysis revealed, Ethiopia’s export is primarily dominated by agricultural products whereas, the import is largely dominated by capital goods, consumer goods, and fuel. The regression results disclosed that devaluation improves short and long-term trade balance. However, there is no evidence of the J-curve phenomenon. Both home and foreign income are positively and significantly related with the improvement in the trade balance while money supply and government expenditure are negatively and significantly related with the improvement in the trade balance. Hence, promoting domestic economic growth, Birr devaluation, tight fiscal and monetary policy, and reduction of trade barriers would improve the trade balance of Ethiopia.