The Relationship Between Real Exchange Rates and International Trade in Kenya

Abstract

Since time in memorial, many countries including Kenya, have been seeking ways of strengthening international trade and its benefits and this has attracted researchers in both academia and policy-making. The relationship between the real exchange rate and international trade has generated much interest, and thus an overview of the theoretical and empirical literature in various countries however does provide us with a definitive answer one can pin down between the relationship of the real exchange rate and international trade especially after the breakdown of the Bretton Woods system of fixed exchange rates. This study therefore examined the significant relationship between the real exchange rate and international trade in Kenya. This paper provides an extensive survey of the literature on the real exchange rate and trade, examining both the theory that underlies the work in this area and the results of empirical studies published. In the methodology the study utilized secondary data on an annual basis for the period 1993 to 2007. The paper utilized both descriptive analysis and inferential statistics to examine the relationship between the real exchange rates and international trade. The Pearson's product moment method of con-elation was used to estimate the parameters and the ordinary least squares method was used for further analysis, in order to determine the significance of the contribution of the specific variables to the export and import volumes. By examining exports and imports in Kenya for the period 1993-2007, the study found that the relationship of the real exchange rate and international trade had been exaggerated. It was concluded that although there was a relationship between the RER, exports and imports in Kenya, the relationship was insignificant. The shilling's recent volatility did not appear to have significantly influenced Kenya's exports and imports. However like studies of similar nature, this study acknowledged that other factors like GDP play a vital role in influencing exports and imports. These results arguably point out several issues of policy concern and call for a rethinking of the strategies practiced in a number of countries of manipulating RER in an effort to enhance International trade. The study suggests that the government should concentrate on improving GDP which is a much more important indicator when compared to RER in the determination of international trade.