The Effect of Foreign Exchange Rate Volatility on Kenyan Export Trade

Abstract

The Kenyan export sector is a key contributor to the country`s economic performance. The markets for Kenya’s exports are majorly the United States of America and Europe. The currencies for these countries are the dollar and the Euro respectively. These being different currencies therefore, the issue of foreign exchange rate present itself since exports from Kenya are given a value in-terms of the market to which the products are destined. Kenya operates a floating exchange rate system where the exchange rate is determined by forces of demand and supply for the local currency (Kshs). With this in mind therefore, the value of the Kenyan shilling is never constant against the currencies of its export market. The exchange rate and the export market cannot be looked at independently and therefore the researcher is keen to establish the role of inflation and foreign direct investments as a percentage of GDP in the export trade and their relationship to the exchange rate. The objective of this study was to determine the effect of exchange rate volatility on Kenyan export trade. To achieve this objective, monthly export earnings were obtained from the central bank and analyzed together with monthly exchange rate movements (Kshs Vs USD) that were obtained from the central bank for the period January 2011 to December 2015. The model adopted for this study included monthly inflation indices and Monthly foreign direct investment as a percentage of GDP statistics to derive a wholesome idea of how these factors affect or relate to Kenyan export trade. Multiple Linear regression was employed to determine the relationship between the export trade earnings and foreign exchange rates, inflation indices and FDI as a percentage of GDP for the period 2011-2015. From the findings of this study, it is concluded that the exchange rate is associated to export trade in Kenya with a Pearson correlation of 73%. This means that the movements in foreign exchange rates affect largely export trade in Kenya. The government of Kenya needs to come up with mechanisms to cushion the export sector from these shocks amidst other factors that affect the export industry. The central Bank and particularly its policy makers should create an enabling environment to sustain a stable exchange rate system that is resistant to external shocks occasioned by movements in foreign currencies. It’s also important for the government to diversify its exports to these foreign markets besides boosting the export sector by offering tax incentives and subsidies that with reduce production and export costs. As relates to further research, other studies should be carried out to establish the effect of other factors such as domestic transport infrastructure, institutions among others. Also a longer period of time say 10 years can be considered in another study to capture more seasons of economic significance such as booms and recessions to establish if the findings will be consistent or not with those of this study.