Economic Policy and Household Welfare During Crisis and Adjustment in Tanzania

Appendix A: Computation of the Real Exchange Rate for Tanzania

I APPENDIX A COMPUTATION OF THE REAL EXCHANGE RATE FOR TANZANIA ^Phe method used for computing the real exchange rate is a simplified versio n of theIMF methodology (Maciejewsk i 1983) , as follows. First, we choose the major hard-currency countries that are the main import and export trade partners of Tanzania (excluding trade in mineral fuels). According to Foreign Trade Statistics 198 7 (Bureau of Statistics, Dar es Salaam), there are six such countries that account for the bulk of Tanzanian trade. They are the Federal Republic of Germany (FRG), U.K., Italy, Netherlands, U.S., and Japan. Italy is included because it is a large trade partner, although its currency is not as hard as those of the other countries. These six countries bought 49.2 percent of total domestic exports in 1980, and 41.3 percent of exports in 1987. They were the source of 53.2 percent of total imports in 1980 (69.0 percent without mineral fuels), an d 56. 1 percen t i n 198 7 (64. 8 percen t withou t minera l fuels) . Th e remaining exports and imports are spread among a large number of trade partners , many of which are soft-currency countries . Denote b y eju th e officia l exchang e rat e vis-a-vi s countr y i (i n Ts h pe r currency of country i) in yearf, by £,$, the exchange rate vis-a-vis the U.S. dollar of country f s currency (in units of foreign currency per U.S. dollar) in year t, and by ej%t the Tanzanian shilling officia l exchang e rate versus the U.S. dolla r 193 194 Alexander H. Sarris and Rogier van den Brink in year t (i n Ts h per US$). The n i f th e Tanzanian authoritie s kee p th e cross exchange rates, at the same levels as the internationally determined ones, to avoid arbitrage, it should hold that (A.1) Our computations of implied cross-exchange rates, using official Tsh/US Dollar andIMF published exchange rates, showed that on average the Tanzanian cross rates are kept reasonably close to their international values. For this reason, and lacking long-ter m informatio n o n Tsh rate s versus the various currencies , the relevant rates are computed by using formula (A.l). Denote b y Pu the consume r pric e inde x (CPI ) i n countr y i an d b y Pj t th e Tanzanian national CPI , both in year t. The index of the real exchange rate for Tanzania (RERn) will then be defined as follows: (A.2) where w(i) ar e fixed weight s describe d below , an d 0 denotes a base year . B y applying (A.l), we obtain: (A.3) where inde x 1 is meant to represent the exchange rat e vis-a-vis th e US$. Th e expression (A.3) indicates that the real exchange rate of Tanzania can be written as the product of a real exchange rate vis-a-vis the U.S. dollar, and a "correction factor" that depends on Tanzania's trade composition (the weights w(ij) an d on cross movement s betwee n foreig n currencie s an d th e US$ , relativ e t o thei r respective inflation rates. The weights w(i) ar e computed as follows. First, define the following aggre gates : X= total merchandis e export s o f Tanzani a (i n valu e terms ) t o th e si x countries over a given base period; M = total merchandise imports of Tanzania (in value terms) from the six countries (ove r the sam e base period). The base Appendix A. Computation of the Real Exchange Rate forTanzania 19 5 period could be one or more years. In the following, reference to the base period will be omitted for convenience. I t will als o be understood that all magnitudes are in value terms . Define th e following additiona l magnitudes : X(i) = exports from Tanzania to country /; M(i) = Tanzanian imports from country i. The weights w(i) ar e defined as follows: (A.4) Note that a decline in RERTt implie s an appreciation of the Tanzanian shilling. We can compute a nominal equivalent exchange rate (NEER) that would compensate for over- or undervaluation and that can be visually o...