Responsiveness of merchandise trade flows to changes in the real effective exchange rate in Zambia

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Mwamina-Bantu, Ngwale
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Economic theory on trade flows postulates that depreciation does not guarantee an automatic improvement of the Balance of Payment (BoP) unless the Marshall-Lerner (M-L) condition is fulfilled. In this regard, most Sub-Saharan African countries (including Zambia) are still grappling with the problem of BoP disequilibrium despite experiencing steady depreciation. The objective of the research was to establish if depreciation of Real Effective Exchange Rate improves the Current Account of Zambia’s BoP through growth in non-traditional exports and reduction in imports. The Single Equation Error Correction Model and the Bewely Transformation Regression were applied on 2000q4-2011q4 data obtained from the Bank of Zambia. The findings were that variables in the study are integrated of order 0 and 1 and both the export and import models were cointegrated. Further findings were that both in the short and long-run, depreciation of Real Effective Exchange Rate (REER) increases the real value of exports. The findings also show that in the short-run depreciation is effective in reducing imports but not in the long-run. The results further reveal that in the short-run, the sum of the estimated REER elasticities of exports and imports exceed 1 meaning that the M-L condition holds, thus implying that a real depreciation of the Kwacha improves the BoP. In the long-run, the M-L threshold is not applicable since imports continue to grow despite depreciation signifying that the short-run improvements in the BoP due to depreciation are not predicated on fundamentals. Thus, in the long-run, depreciation can be effective if supplemented with a policy instrument that reduces expenditure on imports. In view of this, the researcher recommends that future studies be carried out, that will focus on finding a complementary policy instrument that would render depreciation effective based on fundamentals. The results also revealed that in the short-run imported inputs increase exports and thus policy makers should be cognisant of this fact and henceforth pursue policies that do not hamper importation of inputs. The study had one major limitation of not having Gross Domestic Product quarterly data which would have been a better proxy for quarterly domestic income. Thus, the researcher recommends that institutions responsible for managing Zambia’s economic data, should urgently improvise a proxy for quarterly national income that would be more representative other than the real total value of imports to help future researchers.
Zambia-Commercial Policy , Foreign exchange rates-Zambia