EFFECTS OF EXCHANGE RATE VOLATILITY ON IMPORTS AND EXPORTS IN KENYA

Purpose: In some market economies, exchange rate may fluctuate significantly relative to major world currencies. This will have a big impact on a country’s trade. Method: This study evaluates the effect of exchange rate volatility on Kenya’s imports and exports during the period 1980 – 2015through estimation of two structural equations; an import function and an export function for the economy whose specification follows standard economic theory. Findings: Results indicate that, real exchange rate volatility significantly affect imports and exports. At 5 percent level of significance, result of the cointegration analysis using Johansen test found the trace statistic for both models to be smaller than the critical, with a maximum rank of two (2). This implied that cointegration was present and that there existed at least two (2) co-integrated equations, in ether bi-directional or uni-directional relationship. This meant that the dependent and independent variables move closely to achieve equilibrium in the long-run among the variables of imports and exports models. Results further show that increased exchange rate uncertainty has substantial adverse effects in the long-run on export function but not on import function. The results further show that, long-run parameter estimates of the models are consistent with economic theory.Policy recommendation: The study recommends that imports and exports activities can be improved if macroeconomic policies aimed at keeping stable real exchange rate are implemented.