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How the exchange rate can be used to improve Kenya’s Trade Balance

  Aug 20, 2014

This year Strathmore Business School’s (SBS) Senior Lecturer and Economics professor, Dr. Robert Mudida embarked on a research to establish ways Kenya can improve on its trade Balance.

Dr. Mudida together with Dr. Guglielmo Maria Caporale from Centre for Empirical Finance, Brunel University, London, UK and Dr. Luis A. Gil-Alana from Navarra Center for International Development, University of Navarra, and Pamplona, Spain published a journal which seeks to find out if the exchange rate policy can be used to improve Kenya’s Trade Balance.

The journal was set to examine if the exchange rate is effective and whether the Kenyan government will be able to use the depreciation in the local currency to boost exports and reduce imports, a test known as the “Marshall Lerner condition”.
The journal considered depreciation rather than devaluation of the Kenyan shilling because this situation is what was considered to be relevant for the period under investigation. The existing empirical evidence on the operation of Kenya’s managed float system suggests that at times of relative tranquility in the foreign exchange markets, the Central Bank of Kenya can smooth out exchange rate volatility with relatively modest interventions; by contrast, more active policies are required in the presence of more volatile exchange rates. (O’ Connell et al., 2010).

The challenges of an excessively weak Kenya shilling were illustrated in 2011 when a vicious cycle was created between inflation and depreciation (Mudida, 2012). This journal therefore aimed to contribute to the debate on the target for the real exchange rate of the Kenyan shilling, which is a particularly interesting one because the primary task of the Central Bank of Kenya is price stability, at present being pursued through inflation targeting, with expected inflation as the nominal anchor. Inflation targeting may be counterproductive in the presence of supply side shocks, which are prevalent in the Kenyan economy (Adam et al., 2010). Therefore analyzing the Marshall Lerner condition in Kenya was important in light of the concerns facing the Kenyan Monetary Authorities.

The Marshall Lerner condition specifies the circumstances in which it leads to an improvement of the balance of trade, depending on the import and export elasticities.

The final results of the journal stated that there exists a well-defined, co-integrating relationship linking the balance of payments to the real exchange rate and relative income. It also states that the Marshall Lerner condition is satisfied in the long run, although the convergence process is relatively slow. It also implies that a moderate depreciation of the Kenyan shilling may have a stabilizing influence on the balance of trade through the current account without the need for the high interest Rates.

About Dr. Robert Mudida:
He is a Senior lecturer at Strathmore Business School and has considerable lecturing experience in the areas of economics, financial management, international finance and general management. He holds a doctorate from the University of Nairobi. Dr. Mudida also possesses an MSc in Financial Economics from the University of London, School of Oriental and African Studies and an MA in international studies from the University of Nairobi.

To read more on the Journal
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