The Role of Currency Fluctuations in Shaping Kenya’s Export Performance

The Role of Currency Fluctuations in Shaping Kenya’s Export Performance

Wendy Mwende Micheni¹, Alex Mbugi Muriungi², Maureen Muthoni Ndagara³, Anita Ncurai⁴

^1,2,3,4Tharaka University Marimanti, Kenya

DOI : https://dx.doi.org/10.47772/IJRISS.2024.808044

Received: 9 July 2024; Revised: 20 July; Accepted: 25 July 2024; Published: 29 August 2024

ABSTRACT

This study explores the impact of exchange rates on Kenya’s export performance from 1990 to 2022. The study utilizes a causal research design and time series data to assess the influence of exchange rate fluctuations, volatility, and relative price levels on export volumes and their contribution to GDP. Descriptive statistics reveal considerable variability, with exports displaying slight positive skewness and exchange rates exhibiting a slightly left-skewed distribution. Unit root tests confirm non-stationarity in the level forms of exports, exchange rates, the export unit value index, and the price level ratio, which become stationary after first differencing, thus suitable for econometric modeling. The Vector Error Correction Model results indicate insignificant long-run effects of exchange rates, export unit value index, andprice level ratio on exports, despite significant short-run adjustments correcting deviations from the long-run equilibrium by approximately 73.4% per period. Short-run analyses show insignificant effects of lagged exchange rate andexport unit value index differences on exports, while price level ratio exhibits a marginally significant negative effect. The research emphasizes the necessity for stable exchange rates to foster a predictable export environment, crucial for attracting investments and sustaining economic growth. The study recommends diversification of Kenya’s export base, enhanced competitiveness through technological advancements and skill development, and creation of financial instruments to mitigate exchange rate risks. Strengthening export promotion initiatives and improving data collection and research are also advocated to support informed policymaking. The study’s findings are pertinent to policymakers, investors, and researchers, highlighting how currency fluctuations affect economic stability, job creation, and living standards.

Keywords: Exchange Rates, Exchange Rate Volatility, Price Levels, Exports and Opportunity Cost.

INTRODUCTION

When a country’s currency depreciates, its value declines compared to another currency, making exports cheaper and thus encouraging exports. Conversely, exchange rate appreciation makes exports more expensive and less competitive. The advancement of the export sector is crucial for international trade and economic stability. Kenya’s economic development heavily relies on the stability of its balance of payments. Fluctuations in export earnings create economic uncertainties that can affect investment levels and efficiency, potentially leading to declining economic growth (Odhiambo, 2022). In least developed countries (LDCs), instability in exports can hinder growth and development by affecting investment and increasing borrowing costs due to balance of payments complexities (Abdelhadi et al., 2019). Therefore, a stable export sector is essential for sustained economic growth and development.

Exports drive economic growth by laying the foundation for industrialization and economic progress. They provide raw materials for industries, create employment opportunities, and generate foreign exchange, improving the standard of living (IMF Report, 2020). Increased production leads to greater efficiency as firms benefit from economies of scale, reducing production costs and enhancing competitiveness in international markets. Profitable export industries can attract investment, improve technological and managerial skills, and boost overall economic consumption. Internationally, exports have been critical drivers of national economies, generating income, creating jobs, and fostering technological advancements (Euis, 2020; Pablo et al., 2020). It is crucial for developing countries to diversify their export base, focus on value-added products, and implement supportive policies to maximize exports’ positive impact (World Bank, 2020).

In the 1990s, Kenya shifted from an import substitution strategy to export promotion, establishing various export platforms such as the Export Promotion Council, Export Processing Zones (EPZ), and Manufacturing under Bond (Bigsten, Kimuyu, & Söderbom, 2010). These initiatives led to a slight improvement in the value of exports as a percentage of GDP. However, despite policy reforms and efforts to boost exports, Kenya’s export sector share of GDP has declined over the years. In the past decade, exports of goods and services have grown, but their percentage share of GDP has steadily fallen (Orindi, 2011). This decline highlights the need for enhanced efforts to boost exports’ role in economic development. Kenya primarily relies on agricultural exports such as tea and horticultural products, which are subject to world price fluctuations and other challenges like unreliable rainfall and high population growth rates (Mwatu, 2021).

Kenya’s economic trajectory from 1990 to 2022 reflects varied GDP growth rates influenced by both internal economic dynamics and global factors (World Bank, 2024). Peak growth periods, such as in 2007-2008 and 2010-2011, saw GDP rates exceeding 8%, driven by robust domestic demand and increased investment inflows. However, challenges including negative growth during the early 1990s and the global financial crisis of 2008-2009 highlighted Kenya’s vulnerability to external shocks and internal imbalances (World Bank, 2024).

Kenya’s GDP is significantly influenced by its export performance, which is closely tied to exchange rate fluctuations. Agriculture, contributing around 34% of GDP, is a major export driver with key products like tea, coffee, and horticultural goods. When the Kenyan shilling depreciates, these agricultural exports become cheaper and more competitive internationally, potentially boosting their volume and positively impacting GDP. However, an appreciating shilling can make these exports more expensive and less attractive to foreign buyers, thereby reducing demand and affecting overall economic growth. The manufacturing sector, a cornerstone of Kenya’s industrialization efforts, contributes around 10% to GDP through exports of textiles and processed foods. This sector is particularly sensitive to exchange rate changes, as a depreciated currency increases the cost of imported raw materials, raising production costs and affecting the pricing of finished goods. Services, including financial services and tourism, account for approximately 45% of GDP, with Nairobi serving as the regional hub for financial activities (Central Bank of Kenya, 2024). The ICT sector has shown robust growth, contributing 8% to GDP, driven by investments in infrastructure and a burgeoning tech ecosystem (Communications Authority of Kenya, 2024). Despite facing challenges such as fiscal deficits and external debt pressures, Kenya’s GDP growth trajectory remains resilient, supported by ongoing reforms and infrastructure investments aimed at enhancing economic stability and fostering inclusive growth.

Foreign Direct Investment (FDI) is another critical component influencing Kenya’s GDP. FDI has been pivotal in enhancing export capacity and driving economic growth, especially in sectors like telecommunications, real estate, and energy. However, exchange rate volatility can impact investor confidence and the stability of the investment climate. A stable and predictable exchange rate is crucial for attracting and retaining FDI, which in turn supports export growth and contributes to GDP. Therefore, stabilizing the exchange rate through sound economic policies is essential for maintaining and enhancing Kenya’s GDP growth. Addressing exchange rate fluctuations can improve the competitiveness of exports, attract more FDI, and ensure sustainable economic development, highlighting the importance of this factor in shaping Kenya’s economic landscape.

Over the past decade, Kenya has experienced fluctuating GDP growth rates, with notable peaks and troughs. The economy grew at an average rate of 5-6% annually and was approximately $115 billion USD in 2023, driven by robust domestic demand, infrastructure investments, and a stable macroeconomic environment. However challenges such as political in stability, drought, and external shocks have occasionally slowed growth, highlighting the need for resilience and diversification.

Exchange Rate and Its Impact on Exports

The exchange rate significantly influences exports by affecting the price competitiveness of a country’s goods and services in the global market. A lower exchange rate can make a country’s exports more affordable for foreign buyers, potentially boosting export volumes (Cheung et al., 2019). Conversely, a stronger exchange rate can lead to higher export prices, potentially reducing demand for exports (IMF, 2019). Exchange rate volatility reflects the uncertainty and risk associated with currency exchange. Firms engaged in international markets face currency risks due to exchange rate volatility, including transaction, translation, and economic risks (Levi, 2019). To manage risks, exporters often resort to financial strategies (IMF Report, 2019). However, persistent volatility can strain trade relationships and impact investment decisions, underscoring the vital role stable exchange rates play in fostering consistent and predictable export environments (Ndagara et al., 2020).

The relationship between exchange rates and the relative price levels of trading partners is pivotal in shaping a country’s export competitiveness. An appreciating exchange rate can make a nation’s exports relatively more expensive for foreign buyers, potentially reducing demand (Cheung et al.,2019). Conversely, a depreciating exchange rate can enhance export competitiveness by making goods and services more attractively priced (IMF, 2019). This relationship is intricately linked to the relative inflation levels among trading partners. Higher inflation in a country compared to its partners can erode its export competitiveness, as its products become relatively more expensive (IMF, 2019). Conversely, lower inflation than trading partners can enhance a country’s export competitiveness, potentially boosting demand for its exports (IMF, 2019).

Statement of the Problem

Despite various incentives, subsidies, and policies by the Government of Kenya to boost export growth, the export contribution to the nation’s GDP continues to decline (World Bank, 2021; CBK, 2021). Enhancing exports fosters sustainable development by driving economic growth, reducing poverty, and improving living standards (IMF, 2020). The government has aimed for an export-led economy through policies and institutions designed to expand exports (Bigsten et al., 2010; USAID, 2018). While these initiatives have increased the nominal value of exports over the last two decades, their impact on the overall economy, as reflected by the GDP proportion, has not met expectations. Limited research has been conducted on the effect of exchange rates on exports. This study aims to fill this gap by providing a comprehensive analysis of how exchange rates influence export volumes and their share in Kenya’s GDP.

Objectives of the Study

The general objective of the study is to examine the effect of exchange rates on exports in Kenya. Specifically, it aims to (i) examine the effect of the exchange rate on exports, (ii) analyze the impact of nominal exchange rates on the volume of exports, and (iii) evaluate the impact of relative price levels on export competitiveness. The study tests the hypotheses that there is no significant effect of the exchange rate, nominal exchange rate, or relative price levels on exports in Kenya. This study is important to various stakeholders such as government policymakers, investors, and researchers. For policymakers, the study offers solutions through statutory measures, policies, and initiatives to stabilize the balance of payments for sustained economic growth in Kenya. Investors can use the findings to guide their investment decisions, and academics and researchers will find a foundation for assessing research gaps in this area.

Significance of the Study.

This research appeals to a wide range of stakeholders crucial to Kenya’s economy. Scholars in international trade, economic policy, and development economics will find its analysis of currency fluctuations and their impact on exports valuable. Policy-makers, including government officials and central bankers, can use evidence-based recommendations to stabilize exchange rates, enhance export competitiveness, and promote sustainable economic growth. Businesses, investors, and economic analysts gain insights into Kenya’s economic dynamics, aiding strategic decision-making. The study also highlights how stable exchange rates can affect job creation, income levels, and overall economic stability for ordinary citizens, aiming to mitigate risks and support socio-economic development across Kenya.

Scope and Limitations of the Study

The study focuses on the effects of exchange rates on exports in Kenya from 1990 to 2022, using time series data from the Kenya National Bureau of Statistics (KNBS) and World Bank, World Development Index. This period is ideal for identifying the macroeconomic variables affecting exports in Kenya, with an emphasis on the exchange rate, exchange rate volatility, and relative price levels. However, the study relies on secondary data, which may have limitations in accuracy and completeness. Despite these limitations, the study aims to provide valuable insights into the relationship between exchange rates and export performance in Kenya.

LITERATURE REVIEW

Theoretical Frameworks

Comparative Advantage Theory

David Ricardo’s classical theory of comparative advantage, developed in 1817, aims to explain why countries engage in international trade, even when one country may have more efficient workers capable of producing every good more efficiently than workers in other countries. The theory asserts that if two countries with the ability to produce two different commodities engage in free trade, each country will increase its overall consumption by exporting the good for which it has a comparative advantage and importing the other good. This assumption relies on the existence of differences in labor productivity between the countries.

Ricardo’s theory emphasizes that comparative advantage, rather than absolute advantage, drives much of international trade. This focus on opportunity cost allows countries to benefit from trade by specializing in goods where they are relatively less inefficient. This theory is crucial for understanding Kenya’s engagement in international trade, particularly how exchange rate fluctuations might influence which goods Kenya specializes in and exports. As exchange rates impact production costs and international competitiveness, they can shift the comparative advantage dynamics.

Relative Price Theory

The concept of relative prices is fundamental in international trade and macroeconomics. This theory serves as a framework for understanding how changes in exchange rates impact the competitiveness of a country’s exports. Fluctuations in exchange rates can alter the relative costs of producing goods and services across different countries. A depreciation of the Kenyan shilling, for example, would make Kenyan exports cheaper for foreign buyers, potentially increasing demand. Conversely, an appreciation would raise the prices of Kenyan exports in international markets, possibly reducing competitiveness. This theory is directly relevant to the study as it highlights the link between exchange rate movements and export performance. By examining how exchange rate fluctuations affect relative prices, policymakers can anticipate potential impacts on Kenya’s trade.

Purchasing Power Parity (PPP) Theory

PPP theory is based on the law of one price, which states that identical goods should have the same price when expressed in a common currency. This theory suggests that exchange rate changes should reflect changes in inflation rates between two countries, ensuring that currencies adjust to maintain parity in purchasing power. Incorporating PPP theory helps explain how currency movements impact the ability of Kenyan goods to compete internationally based on changes in relative prices due to inflation rates. This theory is essential for understanding the long-term equilibrium of exchange rates and its effect on Kenya’s export competitiveness.

Empirical Review

Exchange Rate and Exports

Nguyen et al. (2021) analyzed the impact of exchange rates on exports and imports in Vietnam, focusing on trade with the United States. Using time series data from 2010 to 2020 and ARDL and NARDL models, the study found that real exchange rates impact exports and imports, but trade wars have a greater influence. In the short run, real exchange rates reduce the trade balance. This study focuses on exchange rate effect on Kenya’s exports.

Gor et al. (2020) examined the link between real exchange rates and exports in Armenia using rolling regression on quarterly data from 2001 to 2021. The study found an insignificant impact of exchange rates on exports. The current research focuses on Kenya and uses annual time series data, considering the differences in governance policies, economic growth rates, and political environments.

Hatab et al. (2010) investigated factors influencing Egyptian agricultural exports using a gravity model approach. The study found that currency depreciation encouraged agricultural exports. The current study, however, examines the effect of exchange rates on all exports in Kenya using a causal research design.

METHODOLOGY

This study adopts a Causal research design to establish the causal relationship between exchange rates and export volumes in Kenya from 1990 to 2022. This period was selected due to major policy shifts from import substitution to export promotion, allowing for in-depth analysis of trends, patterns, and fluctuations and offering valuable insights into the effects of exchange rates on export performance. The research design aims to determine whether changes in exchange rates lead to changes in export volumes, and the extent of such changes. Kenya, an export-oriented economy, provides a suitable context for this study due to its significant portion of GDP derived from exports. The target population includes annual time series data on exchange rates and export volumes.

Purposive sampling was used in selecting annual time series data from 1990-2022 from World Bank’s World Development Index (WDI) database. Ethical considerations are addressed by obtaining consent from the Tharaka University Ethics Review Committee and research authorization from NACOSTI, with all sources acknowledged through citations or references.

The data analysis employs regression analysis to establish the effect of exchange rates on exports, using E-Views software version 10. The Vector Error Correction model (VECM) was utilized due to its ability to combine long-run and short-run dynamics. The stationarity of data was tested using the Augmented Dickey-Fuller (ADF) test, with differencing performed as needed to make the data stationary. Granger causality tests and Co integration tests were conducted to establish long-run equilibrium relationships. Diagnostic checks for multicollinearity, heteroscedasticity, and autocorrelation were performed to ensure the assumptions of the Classical Linear Regression Model (CLRM) hold. The model specification involves defining the variables to be included, with the VECM model specified to estimate both short-run and long-run relationships.

ΔEXPt = β0 + β1ΔEXP(t-1) + β2ΔEXR(t-1) + β3ΔEUVI(t-1) + β4ΔPLR(t-1) + γ1CointEq1(t-1) + εt

Where:

• ΔEXP_t: First difference of exports at time t
• ΔEXP_(t-1): Lagged first difference of exports
• ΔEXR_(t-1): Lagged first difference of exchange rate
• ΔEUVI_(t-1): Lagged first difference of export unit value index
• ΔPLR_(t-1): Lagged first difference of price level ratio
• CointEq_1(t-1): Lagged error correction term
• ε_t: Error term

RESULTS AND DISCUSSIONS

Descriptive statistics

The descriptive statistics for Exports (EXP), Exchange Rate (EXR), Export Unit Value Index (EUVI), and Price Level Ratio (PLR) provide valuable insights into their distributions and characteristics, essential for understanding the study’s data. The mean export value of 21.36103 and median of 21.58757 indicate a fairly symmetric distribution, with a range from 9.640400 to 38.90363 and a standard deviation of 7.102815 highlighting considerable variability. A slight positive skewness (0.430782) and kurtosis of 3.079443 suggest a distribution more peaked than normal. The Jarque-Bera test confirms the normality of the export data.

The exchange rate (EXR) shows a mean of 76.11263 and median of 77.35201, indicating a slightly left-skewed distribution. The range of 22.91477 to 117.8660 and standard deviation of 23.06200 reflect substantial fluctuations. Negative skewness (-0.444345) and kurtosis of 2.905779 suggest a flatter distribution than normal. The EUVI, with a mean of 79.85660 and median of 81.40000, shows wide variability and a nearly symmetric distribution. The PLR, having a mean of 0.356413 and median of 0.355687, indicates less variability and a slightly left-skewed, flatter distribution. The Jarque-Bera tests for both EUVI and PLR confirm normal distribution, highlighting the stable patterns in these variables over the study period.

Unit Roots

Stationarity ensures that variables have a stable mean and variance over time, facilitating reliable analysis of their relationships and dynamics.

The unit root test results indicate that the level of exports (EXP) is non-stationary, with a T-statistic of -1.534244 and a P-value of 0.5019, both exceeding the critical values at the 5% significance level. This suggests that EXP may exhibit trends or stochastic trends over the sample period, implying that its level data should not be used directly in econometric models without transformation. However, the first difference of EXP (DEXP) shows a significant T-statistic of -3.382148 with a P-value of 0.0211, indicating stationarity. This transformation removes the non-stationarity observed in the level of exports, making DEXP suitable for further analysis in econometric models such as the Vector Error Correction Model (VECM).

Similarly, the unit root test for the exchange rate (EXR) reveals non-stationarity in its level form, with a T-statistic of -1.544104 and a P-value of 0.4988, indicating potential trends over time. The first difference of EXR (DEXR), however, demonstrates strong evidence of stationarity with a highly significant T-statistic of -4.982254 and a P-value of 0.0004. DEXR’s stationarity after differencing suggests a stable mean over time, making it suitable for modeling in econometric frameworks. The export unit value index (EUVI) and the price level ratio (PLR) exhibit similar patterns. EUVI shows non-stationarity in its level form with a T-statistic of -0.499126 and a high P-value of 0.8784, but its first difference (DEUVI) becomes stationary with a T-statistic of -4.291835 and a P-value of 0.0020. PLR is non-stationary in its level form with a T-statistic of -1.496222 and a P-value of 0.5222, but stationary after differencing (DPLR) with a T-statistic of -5.236176 and a P-value of 0.0002.

In conclusion, the unit root tests reveal that the variables EXP, EXR, EUVI, and PLR exhibit non-stationarity in their level forms but become stationary after taking their first differences (DEXP, DEXR, DEUVI, and DPLR). This transformation ensures that the variables have stable means over time, making them suitable for econometric modeling and further analysis. The findings emphasize the importance of transforming non-stationary data to achieve reliable and valid results in econometric studies.

REGRESSION ANALYSIS

Vector Error Correction Estimates

Sample (adjusted): 1994 2022

Included observations: 29 after adjustments

Standard errors in ( ) & t-statistics in [ ]

Cointegrating Equation:

The cointegrating equation represents the long-term relationship between the variables.

CointEq1 = ΔEXP(t-1) + 0.040885 · ΔEXR(t-1) + 0.093686 · ΔEUVI(t-1) - 69.04717 · ΔPLR(t-1) + 0.373863......(2)

Error Correction Equations:

These equations represent the short-term dynamics and the adjustments towards the long-term equilibrium.

ΔDEXPt = -0.734150 · CointEq1(t-1)+ 0.001350 · ΔDEXP(t-1)+ 0.004110 · ΔDEXP(t-2)- 0.180148 · ΔDEXR(t-1)- 0.101248 · ΔDEXR(t-2)+ 0.035773 · ΔDEUVI(t-1)+ 0.084112 · ΔDEUVI(t-2)- 85.42518 · ΔDPLR(t-1)- 59.54237 · ΔDPLR(t-2)- 0.414309......(3)

Equation for ΔDEXR

=1.660594⋅+1.353215⋅+0.402454⋅−0.866465⋅−0.222555⋅+0.157939⋅+0.081536⋅−106.8404⋅−13.63729⋅−0.809099……….. (4).

Equation for ΔDEUVI

ΔDEUVIt = 1.597314 · CointEq1(t-1)- 1.706470 · ΔDEXP(t-1)- 1.578769 · ΔDEXP(t-2)- 0.217198 · ΔDEXR(t-1)+ 0.402374 · ΔDEXR(t-2)- 0.518025 · ΔDEUVI(t-1)- 0.306508 · ΔDEUVI(t-2)- 70.67853 · ΔDPLR(t-1)- 43.11094 · ΔDPLR(t-2)+ 0.927024.....(5)

Equation for ΔDPLR

ΔDPLRt = 0.009126 · CointEq1(t-1) - 0.006455 · ΔDEXP(t-1) - 0.002697 · ΔDEXP(t-2)+ 0.002634 · ΔDEXR(t-1) - 0.001164 · ΔDEXR(t-2) - 0.000869 · ΔDEUVI(t-1)- 0.000712 · ΔDEUVI(t-2) + 0.254391 · ΔDPLR(t-1) - 0.364332 · ΔDPLR(t-2) + 0.003601......(6)

The Vector Error Correction Model (VECM) results reveal both short-run and long-run relationships between the exchange rate, exports, and other economic variables for Kenya from 1994 to 2022. The cointegrating equation highlights long-run relationships where exports (DEXP) are normalized as the dependent variable. The coefficients for the exchange rate (DEXR), export unit value index (DEUVI), and price level ratio (DPLR) suggest statistically insignificant relationships, despite DEXR and DEUVI having positive coefficients and DPLR having a negative coefficient. The constant term in this equation is 0.373863.

The error correction term (CointEq1) provides insights into short-run dynamics, particularly the speed of adjustment towards long-run equilibrium. The significant negative coefficient for DEXP indicates that deviations from the long-run equilibrium are corrected by about 73.4% in each period. Other variables such as DEXR, DEUVI, and DPLR also show significant roles in this adjustment process, reinforcing their importance in the short-run dynamics. In the short-run, the lagged first differences of the variables show varying effects on exports. The coefficients for lagged exports (DEXP(-1) and DEXP(-2)) are insignificant, indicating no notable short-run impact. The exchange rate (DEXR) exhibits insignificant negative effects, while the export unit value index (DEUVI) shows insignificant positive effects. The price level ratio (DPLR) has a marginally significant negative effect in its first lag, but its second lag is insignificant. The diagnostics of the model, including R-squared values and F-statistics, confirm a good model fit and statistical validity, with no major issues like multicollinearity, heteroscedasticity, or autocorrelation detected.

Effect of the Exchange Rate on Exports in Kenya

The study aimed to examine the effect of the exchange rate on exports in Kenya. The cointegrating equation results indicate that the exchange rate (DEXR) has a positive coefficient of 0.040885, but this effect is not statistically significant (t-statistic of 0.22081). This suggests that, in the long run, changes in the exchange rate do not have a significant effect on the level of exports. This finding supports the null hypothesis (H₀₁) that there is no significant effect of the exchange rate on exports in Kenya. This finding is consistent with studies such as Bahmani-Oskooee and Ratha (2004), who found that exchange rate volatility has an insignificant effect on trade flows in developing countries. However, it contradicts other studies like those by Rose (2000), who found that exchange rate variability has a significant negative impact on trade volumes. Recent studies such as Fowowe (2021) have also highlighted that exchange rate volatility may not uniformly impact exports, suggesting that sector-specific factors and the nature of the exported goods can influence the overall effect. For instance, manufactured goods might be less sensitive to exchange rate changes compared to primary commodities (Auboin & Ruta, 2013).

Impact of Nominal Exchange Rate on Volume of Exports in Kenya

The analysis also focused on the impact of the nominal exchange rate on the volume of exports. In the long run, DEUVI has a positive coefficient of 0.093686 in the cointegrating equation, though this is not statistically significant (t-statistic of 0.78181). This implies that, in the long run, changes in the export unit value index do not significantly affect the level of exports. In the short run, the lagged first differences of DEUVI (D(DEUVI(-1)) and D(DEUVI(-2))) show varying effects on exports. The coefficient for D(DEUVI(-1)) is 0.035773, and for D(DEUVI(-2)) is 0.084112, with t-statistics of 0.39749 and 1.03852, respectively. Although these coefficients are positive, they are not statistically significant. This suggests that short-term changes in the export unit value index do not have a significant impact on export volumes.

Similarly, the short-run coefficients for the lagged differences of the exchange rate (D(DEXR(-1)) and D(DEXR(-2))) are negative but not statistically significant, indicating that short-term changes in the nominal exchange rate do not significantly impact export volumes. This supports the null hypothesis (H₀₂) that there is no significant impact of the nominal exchange rate on the volume of exports in Kenya. This finding aligns with studies by McKenzie and Brooks (1997), who found that nominal exchange rate changes do not significantly affect export volumes in the short run. Conversely, other studies, such as those by Kandil and Mirzaie (2002), found that exchange rate movements can have significant short-term impacts on exports, highlighting the diversity of findings in the literature. More recent research by Cheung and Sengupta (2013) suggests that while exchange rate levels may not significantly influence export volumes, exchange rate misalignments, where the currency deviates substantially from its equilibrium value, can impact trade flows.

Impact of Relative Price Levels on Export Competitiveness in Kenya

The study also evaluated the impact of relative price levels on export competitiveness in Kenya. The long-run coefficient for the price level ratio (DPLR) is negative (-69.04717) but not statistically significant (t-statistic of -1.44975). In the short run, the lagged differences of the price level ratio (D(DPLR(-1)) and D(DPLR(-2))) also show negative coefficients, with D(DPLR(-1)) being marginally significant. These results suggest that relative price levels do not have a significant impact on export competitiveness in the long run, supporting the null hypothesis (H₀₃).Studies such as those by Hooper and Kohlhagen (1978) have shown that price competitiveness is crucial for export performance. However, the insignificant results in this study suggest that other factors might be more influential in determining Kenya’s export competitiveness. This finding is consistent with Rodrik (2008), who argues that structural factors and global economic conditions play a significant role in export performance. Recent studies by Eichengreen and Gupta (2013) have also emphasized the importance of structural reforms and institutional quality in enhancing export competitiveness, which may outweigh the influence of relative price levels.

Research Summary

This study explores the impact of exchange rates on the export performance of Kenya from 1990 to 2022, emphasizing the crucial role of a stable export sector for economic growth. The research adopts a causal design, utilizing time series data to assess how fluctuations in exchange rates, exchange rate volatility, and relative price levels influence export volumes and their share in Kenya’s GDP. Key theoretical frameworks include Comparative Advantage Theory, Relative Price Theory, and Purchasing Power Parity (PPP) Theory, which collectively provide a foundation for understanding international trade dynamics.

CONCLUSIONS

In conclusion, the results of the VECM analysis indicate that the exchange rate and relative price levels do not have significant long-run effects on exports in Kenya, although there are some short-run dynamics at play. These findings support the null hypotheses (H₀₁, H₀₂, and H₀₃) that there is no significant effect of exchange rates or relative price levels on exports in Kenya. This aligns with some studies while contradicting others, highlighting the complexity and context-specific nature of the relationship between exchange rates and export performance. The findings further, indicate that exchange rates significantly impact Kenya’s export volumes and overall economic performance. Specifically, a depreciating Kenyan shilling tends to boost export volumes by making goods more competitively priced in international markets. However, exchange rate volatility poses substantial risks, complicating trade relationships and investment decisions. The study confirms the need for stable exchange rates to foster a predictable export environment, crucial for attracting investments and achieving sustainable economic growth. Despite policy efforts to enhance export performance, the proportion of exports in Kenya’s GDP has not met expectations, underscoring the necessity for further reforms.

Policy implications

The study focus on the impact of exchange rate fluctuations on Kenya’s export performance, directly affects the ordinary livelihoods of individuals in several ways. First, fluctuations in exchange rates can influence the prices of imported goods, affecting the cost of living for ordinary citizens. A depreciating local currency may lead to higher prices for imported essentials like fuel, food, and machinery, impacting household budgets and inflation rates. Second, since exports contribute significantly to Kenya’s economy, any instability in export volumes due to exchange rate volatility can affect job security and income stability, especially in sectors reliant on international trade. Reduced export earnings may constrain government revenue, potentially impacting public services and infrastructure development essential for citizens’ quality of life. Moreover, uncertainty in export markets can deter foreign investment, limiting job creation opportunities and economic growth prospects. Therefore, the findings from this study can guide policymakers in implementing measures to stabilize exchange rates and support sustainable economic development, ultimately aiming to improve the everyday lives of Kenyan citizens.

RECOMMENDATIONS

1. Stabilizing Exchange Rates: Policymakers should focus on maintaining stable exchange rates to reduce volatility, ensuring a predictable environment for exporters. This can be achieved through prudent monetary and fiscal policies.
2. Diversifying Exports: Kenya should diversify its export base by promoting value-added products and reducing reliance on agricultural exports, which are vulnerable to price fluctuations and climatic conditions.
3. Enhancing Export Competitiveness: Investment in technological advancements and managerial skills is essential to boost the efficiency and competitiveness of Kenyan exports in the global market.
4. Supporting Export Promotion Initiatives: Strengthening institutions like the Export Promotion Council and Export Processing Zones can further enhance the capacity of exporters, enabling them to take full advantage of international trade opportunities.
5. Mitigating Exchange Rate Risks: Developing financial instruments to hedge against exchange rate risks can protect exporters from adverse currency movements, fostering a more resilient export sector.
6. Improving Data and Research: Continuous research and accurate data collection on export performance and exchange rate dynamics are crucial for informed policy making and strategic planning.

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