Impact of Exchange Rate Devaluation in Ethiopia and Forecasting Foreign Exchange Rate Using ARIMA Model

Abstract

The exchange rate is an important indicator of economic activity that policymakers use to formulate policies. This paper is based on fitting historical nominal exchange rate time series expressed in terms of past values of itself plus current and lagged values of error term using the Autoregressive Integrated Moving Average (ARIMA) model over the period 1971-2020, resulting in the model (2,1,1) to forecast the next 15 years. The projection's performance is assessed using data from the preceding fifty years sourced from World Bank, and the forecast indicates that domestic currency depreciation will become more prevalent in order to stimulate exports. Moreover, the ARDL model is used to examine the impact of exchange rate, import, export, and inflation rate on RGDP from 1977 to 2018. The unit root test (Augmented Dickey- Fuller test) was used to verify the integration order of the variables. The five variables are used in the cointegration analysis. The bounds test of cointegration was used in this work. The results showed that the F-statistics value is greater than the upper boundaries at all levels of significance, indicating that individual variables have a long-term relationship with RGDP. This led to the estimation of the Error Correction Model (ECM), in which 25.1 percent of the disequilibrium is adjusted annually to bring the system back into equilibrium. Furthermore, nominal exchange rate and import has positive contribution to RGDP while inflation has adverse effect on RGDP in the long-run. Besides, inflation has a negative impact to RGDP in the short run due to its lag period effects.

Keywords: forecasting, ARIMA model, ARDL model

DOI: 10.7176/EJBM/13-17-02

Publication date:September 30^th 2021