Asymmetric effect of real effective exchange rate and trade balance adjustment: The case of Rwanda

Abstract

This paper investigates the empirical evidence of the impact of exchange rates on the trade balance in Rwanda. A novel feature of the study is the focus on examining whether the relationship between real exchange rate and trade balance is symmetric or asymmetric by comparing results from linear and nonlinear Autoregressive Distributed Lag (ARDL) models respectively. The non-linear ARDL approach to cointegration and the associated error correction methodologies examines whether Rwandan francs appreciations affect trade differently than does Rwandan francs depreciations. We use quarterly data spanning the period 2000Q1 to 2020Q4. Results from the linear model reveal that the real exchange rate does not affect trade balance in the short-run whereas it improves trade balance in the long run, partially confirming the J-curve phenomenon. The empirical findings from the non-linear model revealed that depreciations improve the trade balance in the long run whereas appreciations have no impact. The Wald test results indicate the existence of significant long-run asymmetric effects of REER on the trade balance, while short-run asymmetry was not supported. In light of the results obtained, policymakers should be aware of the consequences of asymmetric impacts of Rwandan francs’ appreciation and depreciation in the development of trade policies so that international competitiveness is not adversely affected.