Effect of Exchange Rate Misalignment on Bilateral Trade between Kenya and European Union
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Date
2020
Authors
Gachoki, Charles Munene
Journal Title
Journal ISSN
Volume Title
Publisher
Kenyatta University
Abstract
The exchange rate is an important variable in international trade due to the expectations
that trade reacts to its movements and therefore determines a country’s international
competitiveness. Prudent management of trade and exchange rate policies have been
associated with faster growth in developing countries. In order to orient the economy
outwards, Kenya has pursued various measures from 1990s to 2000s. Despite these export
oriented efforts, Kenya’s trade has remained skewed towards imports and a widening trade
deficit which seems to follow the weakening of the Kenya shilling. The main policy
dilemma is therefore how imports accelerated in an environment of unhindered European
union market access, and hence the motivation of this study. The key objective of this study
was to investigate the effect of exchange rate misalignment on Kenya’s bilateral trade with
the European Union. Secondary data was used on variables considered instrumental in
influencing trade between Kenya and EU for the period between 2000 and 2016. Data was
collected from Kenya National Bureau of Statistics, Central Bank of Kenya, EuroSTAT
and IMF financial statistics. The study adopted a dynamic modelling approach since
exchange rate and trade are affected by previous as well as present values. The study results
show that the real exchange rate is driven by the economic fundamentals and in terms of
misalignment the exchange rate is overvalued to maximum of 5.9 percent and undervalued
up to 5.2 percent. The estimated misalignment has a negative effect on imports but positive
statistically insignificant for exports. Finally, the exchange rate has a positive effect on
trade balance. The results of this study suggest that the monetary authority should ensure
the exchange rate remains stable and within the 6 percent range while monitoring all the
underlying determinants. Coupled with this, hedging instruments should be made available
and affordable.
Description
A Thesis Submitted to the Department of Applied
Economics in the School of Economics in Partial
Fulfillment of the Requirements for the Award of the
Degree of Doctor of Philosophy in Economics of Kenyatta
University.
Keywords
Exchange Rate Misalignment, Bilateral Trade, European Union, Kenya