MST-Department of Economic Theory

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Browsing MST-Department of Economic Theory by Subject "Balance of Payments"

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    Relationship between Tea Production, Balance of Payments and Exchange Rate in Kenya, 1996-2018
    (Kenyatta University, 2023-10) Kahure, Peris Njeri; Samuel Muthoga
    Compared to other tea producers, Kenya is the third largest behind India and China. Tea production has doubled over the last two decades due to new small-scale farmers' entrance and acreage under Tea. Tea is one of Kenya's major exports, and an increase in tea production results in higher exports, which, in turn, positively impacts the country's trade balance. A favourable BOP is crucial for overall macroeconomic stability. However, despite the continued increase in tea production and export in Kenya, the effect of foreign inflows does not seem to strengthen the Kenya shilling against the dollar. Furthermore, the balance of payment has remained negative and even deteriorating since 1996. Whether (or not) tea production affects exchange rates and balance of payment or whether (or not) the effects are eroded by increased imports of other goods, thus lowering the balance of payment, is a policy question not adequately covered in the empirical review. This study investigates the intricate relationships between tea production, balance of payments (BOP), and exchange rates in Kenya from 1996 to 2019. It seeks to shed light on the extent of these connections and their policy implications for Kenya's economic landscape. The study adopts a quantitative approach, utilising secondary time series data from reputable sources, including the Central Bank of Kenya, the East Africa Tea Auction, and the World Bank database. An Ordinary Least Squares regression model was used to estimate the model of the data. Unit root testing was carried out using the Augmented Dickey-Fuller and Phillip Perron techniques. A causality test was also performed to determine whether the variables' correlations were unidirectional or bidirectional. Through the utilisation of an Ordinary Least Square (OLS) regression model, the study unveils a significant and negative relationship between tea production and the BOP. In essence, this signifies that an increase in tea production leads to a subsequent increase in tea exports, reducing the BOP deficit. Notably, the model demonstrates that approximately 60.2% of the variability in the BOP can be explained by changes in tea production. The study also conducts Granger causality tests further to elucidate the connection between tea production and the BOP. The results reveal a one-way relationship: tea production significantly influences the BOP, while the BOP has no discernible impact on tea production. Subsequently, the study delves into the association between tea production and the Kenyan exchange rate. However, unlike the relationship with the BOP, the study uncovers that tea production has a negative, but statistically insignificant, effect on exchange rate volatility. The relationship between these variables appears to be weak, with variations in tea production accounting for just 3.6% of the changes in exchange rate volatility. Granger causality tests reinforce the findings, indicating a lack of directional causality between tea production and exchange rate volatility. In other words, changes in tea production do not lead to significant shifts in exchange rate volatility. These findings present a vital tool for the National Treasury, the Ministry of Trade and the Ministry of Agriculture in designing agricultural policies as a means of reducing the BOP deficits. There is a need for the National Treasury and Ministry of Trade to explore this linkage in managing the deficits by increasing agricultural production through policies such as subsidisation of agricultural imports like fertilisers and equipment by 1% in order to realise up to 3150.9% results.