Does Currency Devaluation Improve the Trade Balance in the Long Run? Evidence from Malawi

Abstract

This paper explores the impact of nominal exchange rate devaluation on the trade balance for Malawi. A small-open economy IS-LM aggregate supply model of Malawi estimated using time series data covering the period 1967-96 is used in the simulation analysis. The results of the simulation experiment show that devaluation helps to improve export performance and to curtail the growth of imports in the long run, which lead to improvement in the trade balance position. The results provide evidence supporting the view that nominal devaluation can indeed be a quite powerful tool in minimizing the imbalances in Malawi's international trade.Re´sume´: Le pre´sent article analyse l'incidence de la de´valuation du taux de change nominal sur la balance commerciale du Malawi. Ses auteurs se servent d'un mode`le IS-ML d'entreprise en e´conomie ouverte spe´cialise´e dans la fourniture d'agre´gats, cense´utiliser des donne´es chronologiques concernant la pe´riode 1967 a`1996, a pour effectuer cette analyse. Les re´sultats de cet exercice de simulation montrent que la de´valuation contribue, a`long terme, a`ame´liorer la qualite´des exportations -et, partant, la situation de la balance commerciale -et a`freiner la croissance des importations. Ils viennent, en outre, appuyer la the´orie selon laquelle la de´valuation peut, en re´alite´, contribuer sensiblement a`re´duire les de´se´quilibres du commerce international au Malawi.

Exchange Rate Policy and Export Performance in Efficiency-Driven Economies

“…These studies (refer Appendix 9.1) have largely adopted either panel data models (Berman & Berthou, 2009;Santos-Paulino, 2002); or undertaken time series analysis (Owen, 2005). Musila and Newark (2003) examine four empirical approaches to such research. Such approaches include a 'before-and-after' approach, which examines changes in the trade balance at the time of devaluation; a control group approach, where a sample of devaluing countries are compared to a control group of non-devaluing countries; a time series approach; and a macro-simulation model (Musila & Newark, 2003).…”

“…Research done by Bautista (1982), Abeysinghe and Yeok (1998), Musila and Newark (2003) and Auer and Chaney (2009) found that currency weakness improves export performance. However, contrary findings were presented in studies done by Lizondo and Montiel (1989), Calvo and Reinhart (2000), Musila (2002), Frankel (2005 and Berman and Berthou (2009), where currency weakness was found to have either a negative effect on export performance, or little effect.…”

“…Bank to adopt policies of floating exchange rates to facilitate price corrections and promote export led growth (Musila & Newark, 2003). Historically, however, with the legacy of the fixed-rate Bretton Woods system (Dooley et al, 2004), some reluctance amongst policy makers to relinquish control over the exchange rate has been experienced.…”

“…An increase in export performance could be seen in an increase in export market share (Durand & Giorno, 1987); export growth (Sousa, 2004) or an improved balance of trade (Santos-Paulino, 2002) which refers to net exports, or the difference between exports and imports for a country (Musila & Newark, 2003). Sousa (2004) shows that export growth is one of the most prevalent indicators of export performance in the review of 43 empirical studies on export performance published between 1998 and 2004.…”

“…Fears also exist that any increase in export performance may not cover the additional costs incurred due to the effect of currency depreciation on import costs (Musila & Newark, 2003). Further, Clark (1996) found that, in the case of sensitive export products, an importing country may consider the erection of protectionist barriers to counteract the effects of significant currency devaluation and apply pressure for a revaluation.…”