Impact of oil price on real exchange rate in Kenya

Abstract

This study investigated the impact of oil prices and interest rate on Kenyan’s real effective exchange rate using monthly time series data between 1997 and 2016. This study employed time series econometrics techniques. Cointegration was used for long relationship test while OLS gave out the empirical results. The result from cointegration revealed that real interest rate, oil prices and real effective exchange rate had a long run relationship. VECM estimates showed that both real oil prices and real interest rate were statistically significant in influencing the country’s real exchange rate. Further, the study revealed that oil prices had a positive influence on real exchange rate implying that a rise in oil prices weakened the Kenyan shillings. Finally, the study also found a positive relationship between real interest rate and real exchange rate confirming with theory which states that an increase in interest rates leads to an appreciation of the domestic currency. The study also pointed out appropriate policy measures that the government can adopt; in addition to recommending further research on the role of debt burden and foreign direct investment on real exchange rate.