Does real exchange rate devaluation improve the current account balance of highly indebted low income countries?

Abstract

Purpose The purpose of this paper is to examine whether real exchange rate devaluation improves the current account balance of four highly indebted low-income countries of East Africa. Design/methodology/approach The pooled mean group (PMG) approach is used for panel data from four countries over the period 1970–2016. The paper also applied bound testing and ARDL model for time-series data from individual sample countries. Findings The panel PMG/ARDL estimation result reveals that real exchange rate devaluation has no significant impact on the current account balance, both in the short and long run. However, the time-series analysis using the bound testing and restricted ARDL estimation suggests that real exchange rate devaluation improves the current account balance in the long run for only Ethiopia. The overall empirical results reveal that the current account balance would improve with the rising domestic income while it deteriorates with increasing foreign income and external indebtedness in the long run. Originality/value The paper is original.

Real exchange rate misalignment and economic growth in East African least developed countries

“…Indeed, RER depreciation (appreciation) may not always result in better (poor) competitiveness ( Bella et al., 2007 ; Ayele, 2019 ). Many empirical studies ( Terra and Valladares, 2010 ; Couharde and Sallenave, 2013 ; Schroder, 2013 ) stated that extreme undervaluation of currency beyond the threshold level could hamper economic growth.…”

Impact of Currency Devaluation on Economic Growth: Evidence from Pakistan

“…This statement was also supported in the following studies : Cheng, 2020;Ayele, 2019;Nawaz et al, 2018;Abdul Sattar et al, 2015;and Mohsen Bahmane-kooee et al, 2014. In addition, to the stability of the model, we performed a diagnostics test.…”

“…If the quantity of demand elasticity of imports and demand elasticity of foreign exports is more than 1, the Marshall Lerner condition states that currency devaluation will recover the trade balance in the long term. On the other hand, Ayele (2019) says, if the country initially runs a huge trade deficit, then the sum of demand elasticity of exports and imports even exceeds unity, but the devaluation will cause to increase in imports of goods and services than export receipts.…”

“…However, these countries have experienced a weakening in the country's institutional environment or been affected by external factors that offset any potential gains from the devaluation. Besides, Ayele (2019) worked on low-income countries' real exchange rates and current account balances in Africa. The paper's purpose was to point out whether devaluation improved the current account balance of four less developing countries in East Africa: Ethiopia, Kenya, Rwanda, and Tanzania.…”

“…The remedy is sometimes worse than the disease due to political instability and macroeconomic and environmental conditions in the country. The impact of currency devaluation varies from country to country based on macroeconomic conditions (Ayele, 2019). Shahbaz et al (2012) pointed out that real devaluation had a contractionary effect and positively impacted Pakistan's economic growth.…”