THE EFFECT OF DEVALUATION ON TRADE BALANCE IN ETHIOPIA

Abstract

Previous studies and economists argue that there is no agreement regarding the effect of devaluation on the economy and particularly on trade balance. This study seeks to contribute some disagreements in the literature by investigating the effect of devaluation on Ethiopian trade balance using time-series data (a sequence of numerical data points in successive order) that covers the period 1997-2018. The study employs the Autoregressive distributed Lag (ARDL) approach and Error Correction Model (ECM) for analysis. The findings of the study show that trade balance positively and significantly associated with the long run devaluation. The error correction model (short run) coefficient also shows that the adjustment of disequilibrium in the subsequent year is significant. Overall, the study finds that devaluation of the Ethiopian Birr could improve Ethiopia’s trade balance. However, the study cautions that consecutive devaluation of the currency would not improve trade balance in the country. This is because of the non-responsiveness of import to devaluation, shortage of domestic products that could substitute imports, and the staggering dependency of exports on primary agriculture products. Therefore, government policy should encourage and subsidize the infant industries Promote enterprises that are the source for manufacturing industries to raise the export commodities of the industrial products in the country through research and development.