The Effects of Currency Devaluation on Coffee and Khat Export Performance in Ethiopia: Evidence from Vector Error Correction Model and Johansen Co-integration Test

Abstract

Devaluation of currency has been stipulated and utilized increasingly as a stabilization device in developing countries, as part of International institutions’ programme. To improve the export performance of agriculture and earnings, the Ethiopian government employed devaluation policy. However, devaluation of currency has an ambiguous effect on export performance in Ethiopia. Therefore, the prime objective of the study was to investigate the effect of domestic currency devaluation on coffee and khat export performance in Ethiopian by employing time series data for the period 1987-2020. With the help of Johansen’s co-integration and vector error correction modelling methods to attain the research objectives, the impact of real effective exchange rate on coffee and khat was assessed in the long-run as well as in the short-run. The study found that real effective exchange rate has positive and significant relationship with value coffee and khat in the long run. Which implies the decrease /devaluation in the value of domestic currency promotes exports of coffee and khat in the long run. Other variables like foreign direct investment with the expected positive sign and real gross domestic product with negative sign are also found to be statistically significant in explaining export in the long-run. The study revealed that foreign direct investment and foreign real income, which shows the demand side influencing factor, had significantly influenced the export performance of coffee and khat in Ethiopia in the short run. The findings of this paper suggest that policy intervention in the form of depreciating domestic currency aimed at improving the country’s exports should be sector-targeted, and that such a policy intervention could be effective in improving the export performance when the effect of inflation on output is controlled.