FOREIGN EXCHANGE RATE VOLATILITY AND ITS EFFECT ON INTERNATIONAL TRADE IN KENYA

Abstract

Exchange rate volatility has received much attention in economic research especially with the advent of floating exchange regimes. The volatile nature of exchange rate is generally perceived as having negative affect on international trade. However, theoretical and empirical perspectives are mixed on the nature of relationship. This study examined foreign exchange rate volatility and its effect on international trade. It used error correction model in analysis of time series data for the period 1966-2018. A negative relationship existed between foreign exchange rate volatility and international trade volumes. Controlling inflation rate, interest rate and gross domestic product, foreign exchange rate had a negative and significant effect on export volumes with a p<0.05 and R2 of 0.9864. Foreign exchange rate volatility have a negative and significant effect on import volumes with a p<0.05 and R2 of 0.9924. Controlling for inflation rate, interest rate and gross domestic product, foreign exchange reserves had a positive and significant moderating effect on the relationship between foreign exchange rate volatility and international trade with p<0.05 and R2 of 0.9557. The study recommends formulation and implementation of policies that address core causes of exchange rate volatility to improve stability to gain maximum benefits from international trade. It also recommends improvement of exports and reduction of overdependence on imports alongside maintaining enough stock of foreign exchange reserves to cushion adverse effects of exchange rate volatility