Real Exchange Rate Behaviour In Tanzania

In this study the behaviour of Tanzania's real exchange rate for the period 1966 to 2001 is examined through investigating the determinants of real exchange rate and its misalignment. The period was chosen to cover the years in which the Bank of Tanzania has been under operation. The study has employed econometric techniques of time series, with exchange rate misalignment analyzed using two approaches, the first one being use of the difference between actual real exchange rate and equilibrium real exchange rate and the second one using exchange rate premium as a proxy of misalignment. The results show that the long run determinants of real exchange rate in Tanzania include debt servicing, openness, terms of trade and reforms. The main hypothesis that periods of major external imbalance, foreign exchange control and fixed exchange rate regime are characterized with exchange rate misalignment which tend to disappear during the period of floating exchange rate regime was not rejected. Hence the conclusion that the period of major external imbalance, foreign exchange control and fixed exchange rate regime in Tanzania was characterized by exchange rate misalignment, which is disappearing during the period under which the economic reforms are being implemented. In addition, the results show that in the absence of other interventions, actual real exchange rate converge very slowly towards the long run equilibrium level. Hence, the study recommends the use of the nominal devaluation, in the short run as a powerful tool for reestablishing real exchange rate equilibrium.