The impact of real exchange rate volatility on economic growth in Kenya

Abstract

Kenya has witnessed exchange rate volatility following financial liberalization in the late 1980s which led to increased foreign private capital flows. Fluctuations in international world prices attributed to exchange rate volatility which hinders economic growth rate. These fluctuations increase risk and uncertainty in international transactions and thus discourage trade which consequently hampers economic growth. Changes have occurred in foreign exchange market as exhibited by strong appreciation of Kenyan Shilling between 2004 and 2007 of value 30.0% which is a major deviation from its past levels. Therefore, the relationship between exchange rate volatility and economic growth might have changed owing to these changes. This brings about the need of another study to inform the Kenyan monetary policy makers on the impact of exchange rate volatility to allow them make informed decisions concerning monetary. Therefore the main objective of the study was to identify the effect of exchange rate volatility on economic growth in Kenya. Using secondary time series data for the period 1980 to 2012, the study employed OLS estimation method to identify the effect of exchange rate volatility on GDP growth rate. Augmented Dickey-Fuller test (ADF) was used in unit root testing to determine whether the series was stationary or nonstationary and establish their order of integration. The study found that exchange rate volatility positively impacts on GDP growth but is not significant in affecting GDP growth rate. The result differed with Musyoki at el (2012) who found a negative relationship between exchange rate volatility and economic growth in Kenya. The study recommended that policy makers should find equilibrium on the devaluation and appreciation of exchange rate since devaluation of domestic currency provides important opportunity for economic growth, it promotes exports capacity and reduces volume of imports.