Exchange rate volatility and its effects on Uganda’s trade balance (1980–2020)

This research investigates an impact of exchange rate volatility on Uganda’s trade balance. It used macroeconomic variables such as consumer price index (Inflation), real gross domestic product in addition to volatility of exchange rate, foreign direct investment (FDI) and gross capital formation (GCF) to meet the objective of the research. We used a yearly time series data from 1980 to 2020 in the analysis. Augmented Dickey Fuller (ADF) and Phillips Perron (PP) test was used to test for data stationarity whereby the results indicated that some variables were stationary at level while others were stationary after first difference. We used an ARDL bound test to examine the existence of cointegration among the variables and found out that there exist long-run relationships among these variables. An ARDL model was employed and the findings indicated a negative link between volatility of real effective exchange rate and trade balance in the short-run and positive link in the long run proving the existence of J-curve effect. Real GDP, Inflation and Gross capital formation all had a positive impact on trade balance in the long-run while the reverse was true for FDI in the long-run. This research thus suggests that the government of Uganda have to introduce a good structure of hedging facility such as forward markets or organizations in order to protect international trade from facing exchange rate risks during the short-run as well as emphasizing on a stable Uganda shilling’s exchange rates because its movement can affect prices either negatively or positively, hence affecting trade balance.