Empirical Analysis of Exchange Rate Determinants in Rwanda (2000─2015)

Abstract

This study examined the determinants of exchange rate behavior in Rwanda for the period of 2000Q1-2015Q4. The econometrics approach was focused on the extent at which exchange rate correlated with the macroeconomic factors and some elements of non parity determinants of exchange rate. Special emphasis is placed upon the short and long run impact of the regressors. The relationship was investigated by means of the regression analysis. The ordinary least square (OLS) was used to analyze data and confirmed the positive effect of broad money, discount rate, external government debts and real gross domestic products on exchange rate except trade balance, with an adjusted R squared of 94.6% and F statistics of 224.4694 with a very low probability of 0.0000.

The study employed the Co-integration Technique and Error Correction Modeling proposed by Engle and Granger (1987), which provides mechanisms to deal with the problems of Unit Root faced in the time series data. Evidences support the view that, there was one co-integrating equation which normalized the coefficient of log exchange rate. By applying ECM technique the speed of adjustment of the model was 1.3% with an error correction model coefficient of -0.013028 which means that 1.3% of errors realized in previous quarter are corrected in the current one, and each quarter 1.3% of disequilibrium errors was corrected due to any change from the equilibrium.

While analyzing the determinants of exchange rate in Rwanda, most of the test confirmed that explanatory variables are statistically significant in short run at 5% level of significance, and many variables driving long run include broad money and trade balance with a coefficients of 0.969885 and 0.119752 respectively. The highest probabilities indicated by granger causality test confirmed undirection causality between variables. The impulse response function indicated the highest short run effects of discount rate where variance decomposition of log exchange rate supports the evidence of long run relationship between exchange rate and three explanatory variables (money supply, external government debts and trade balance).

Keywords: Exchange rate, non parity elements, Macroeconomic factors, econometric approach