Real exchange rate undervaluation, regional integration and services sector performance: evidence from the East African Community

Abstract

We undertake to estimate the effects of real exchange rate misalignment and regional integration on the service sector performance in selected countries from East Africa during the period of 1991–2017. The main findings, based on the traditional Pooled Mean Group ARDL technique as well as the alternative panel Cross-Sectional Autoregressive distributed lag (CS-ARDL) approach render support for an undervaluation-led services sector performance as well as the importance of regional integration in the observed linkage. Additional evidence reveals that both the monetary policy and the fiscal policy are key channels via which currency undervaluation impacts on the services sector output. The existence of non-linearities in an inverted U-shaped curve is equally confirmed in the data, where small and moderate undervaluations spur service sector performance just as large undervaluations after some threshold hinder it. Exchange rate volatility is found detrimental to the services sector in the long run. Policies that would help promote the underlying catalysts of undervaluation, curtail exchange rate volatility as well as those that promote deeper regional integration should be strengthened. Likewise, undervaluation policies would yield optimal benefits to the services sector once they are accompanied by well-calculated monetary and fiscal policies.

Currency Fluctuations and Foreign Direct Investment in Kenya

“…However, there is no literature investigating the effect of currency changes on FDI. According to Oryema et al (2022) currency is a major consideration by foreign investor based on whether it is overvalued or undervalued and extent of its variability. Despite the effect of currency fluctuations being studied in global literature, the results of such studies are usually inconclusive (Oryema et al, 2022).…”

“…According to Oryema et al (2022) currency is a major consideration by foreign investor based on whether it is overvalued or undervalued and extent of its variability. Despite the effect of currency fluctuations being studied in global literature, the results of such studies are usually inconclusive (Oryema et al, 2022). Despite these efforts by the government to increase FDI, a report by CEIC data has revealed that the percentage of FDI to GDP has been decreasing gradually from 2017 (1.641%) to 2022 (0.347%) (CEIC Data, 2023).…”