The effect of foreign Aid on trade balance in Rwanda
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Date
2015-01-28
Authors
Habakurama, Iradukunda Gallican
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Abstract
Rwandais seen as a good macroeconomicperformerand has achievedhigh rate of growth
and macroeconomicstability.Due to the low level of saving,capital inflowwas necessary
to keep the economybuoyant.The inflowof capitalwas not only importantfor investment
and job creation but also used for capital imports. Production is not satisfying as the
country's imports continue to exceed the exports. The trade gap keeps expanding and
necessitatesmore foreign aid inflow. Increase in foreign aid strengthens domestic
currency in the short run. As result of appreciation of domestic currency, it is
expected that imports will increase and exports decrease in the short run and the
country will experience trade balance deficit. It is also expected in the long run
that foreign aid increases the income of population which increase the imports and
domestic currency is expected to depreciate. This makes the imports expensive and
exports cheaper, therefore trade balance improvement in the long run due to the
fact that domestic currency depreciates and capital imports are producing
substitute and competitive goods. However the situation is controversialin Rwanda,
the more foreign aid inflow, the more trade balance deteriorates while the domestic
currency continuously depreciates. The study intended to determine the effects of
foreign aid on trade balance in Rwanda and specific objectives of the study were to
determine the effect of foreign aid on trade balance in Rwanda, to determine the
effect of exchange rate on trade balance in Rwanda and also to determine the
causal relationship between foreign aid and trade balance in Rwanda. The study
used time series data spanning from 1982 to 2012 and descriptive and econometric
analysis were carried out based on Vector Autoregressive (VAR). Cointegration
and causality tests were used to test the relationship exist between foreign aid and
trade balance. Vector error correction model (VECM) was applied to determine
the speed of adjustment from the short run to the long run economic equilibrium.
The study revealed that there is a negative effect of foreign aid on trade balance in
Rwanda and a positive effect of exchange rate on trade balance in Rwanda. The
study also denoted that there is a bi-directional causality between foreign aid and
trade balance in Rwanda and a long run relationship between trade balance,
Exchange rate and Foreign aid. The test for VECM presented that the speed of
adjustment from short run to the long run equilibrium was faster at 1.43 or 143
percent. It is advised that the republic of Rwanda should implement import
substitution policy in order to reduce the quantity of imports which widens the
trade balance deficit for many years. Export promotion policy should be important
in order to gain enough foreign earnings instead of relying on uncertain foreign
aid. To achieve these GoR should be wisely prepared to tear down all trade
barriers Rwandan exports faced on global market. It is expected that the study is
useful to the macroeconomic policymakers of government of Rwanda towards the
effects of foreign aid on trade balance in Rwanda.
Description
Masters in Economics-Department of Applied Economics, 51p. September 2014