DETERMINANTS of TRADE BALANCE in ETHIOPIA

Abstract

The study has mainly focused on the determinants of trade balance: an ARDL bound testing approach of co-integration. The time periods from 1984/85 to 2016/17 are covered and the impacts of the variables: Real Effective Exchange Rate (REER), Household Consumption Expenditure (HHCE), Government Expenditure (GEX), Money Supply (MS), openness (OP), natural resource availability (MRX & FLM) have been assessed. According to the results of the short run and long run models, real effective exchange rate appreciation has worsened the trade balance both in the long run and short run which is consistent with the research hypothesis. However, the worsening impact of appreciation is significant in the short run than the long run and the elasticity coefficient of Real Effective Exchange Rate not much indicating the fact that the J curve effect and the Marshal-Lerner condition does not hold in the Ethiopian context. In conformity with the research hypothesis and related theories, increased household consumption expenditure induced by GDP growth has a negative effect on the trade balance. On the other hand, an increase in the government expenditure positively affects the trade balance which is inconsistent with the theories. The impact of liberalization (openness) is as expected and statistically significant, where an increased level of openness has affected the trade balance positively. An increase in the money supply has positively affected the trade balance which is inconsistent with related theories. The findings suggest that measures such as devaluation will not succeed in improving the trade balance. Furthermore, policy measures regarding liberalization have to include the inward looking approach (import substitution) in addition to the outward looking export promotion approach since openness/liberalization might have greater impact on increasing imports over exports. Based on the positive impact of GDP, it is advisable to increase the government expenditure on infrastructural development activities that will promote the export as well as import substituting sectors.