Exchange rate volatility and manufacturing trade: Evidence from Africa

Subsequent to the floating of the US dollar in 1973, liberalization of capital flows and the associated exponential growth of cross-border financial transactions during the last three decades, important volatility and uncertainty has been seen in exchange rates (Arize, 1998). Academicians, policy makers, researchers and economists have always raised eyebrows with regards to the potential impact of exchange rate volatility on trade. Taking into account the foregoing, recent volatility in world known currencies and given that African countries rely heavily on manufacturing trade for their survival, this paper analyses the impact of exchange rate volatility on manufacturing trade in a sample of 18 African countries spanning the period 1995-2012 using an import-export model and dynamic panel data econometrics. As measures of exchange rate volatility, the Z score and EGARCH as employed. In a dynamic setting, contrary to what static results suggest, random coefficient estimates reveal that both REER and its volatility are statistically significant in explaining real manufacturing imports and exports using both measures of exchange rate volatility. However, foreign income, contrary to the law of income elasticity of demand is inelastic in explaining the exports. When VaR estimation is employed, however, only when EGARCH is employed, does exchange rate volatility adversely affect real manufacturing imports and exports. The negative impact of exchange rate volatility on manufacturing exports means that the governments of the African states should look for policies to stabilize their external trade position. As the results, the African economies should seek the help of developed and emerging nations in developing their financial markets, more explicitly well-developed hedging instruments and markets. In the same vein, governments should come up with the necessary policies to promote the introduction of institutions to provide such services. The results of the study also have important insights to offer in terms of government macroeconomic policies to stabilise external trade in the African countries such as diversification of markets and payment alternatives and on a regional scene to start thinking about a regional currency pegged to a major world currency.