Effects of Exchange Rates Volatility on Imports and Exports in Kenya

Abstract

In some market economies, exchange rate may fluctuate significantly relative to major world currencies. This will have a big impact on a country’s trade. This study evaluates the effect of exchange rate volatility on Kenya’s imports and exports during the period 1980 – 2015 through estimation of two structural equations; an import function and an export function for the economy whose specification follows standard economic theory. Results indicate that, real exchange rate volatility significantly affect imports and exports. At 5 percent level of significance, result of the cointegration analysis using Johansen test found the trace statistic for both models to be smaller than the critical, with a maximum rank of two (2). This implied that cointegration was present and that there existed at least two (2) co-integrated equations, in and independent variables move closely to achieve equilibrium in the long-run among the variables of imports and exports models. Results further show that increased exchange rate uncertainty has substantial adverse effects in the long-run on export function but not on import function. The results further show that, long-run parameter estimates of the models are consistent with economic theory. The study recommends that imports and exports activities can be improved if macroeconomic policies aimed at keeping stable real exchange rate are implemented.