• The Impact of the Real Exchange Rate Changes on Export Performance in Tanzania and Ethiopia

      Wondemu, Kifle Asfaw; Potts, David J. (2016-08)
      The importance of trade as an engine of growth is well established. Empirical literature shows that the growth impact of exports is much stronger when the export basket is vertically and horizontally diversified. This paper aims to assess the role of the real exchange rate in enhancing export supply and promoting export diversification in Ethiopia and Tanzania. The empirical results suggest that, while overvaluation is harmful to exports, undervaluation of the real exchange rate boosts export supply as well as export diversification. A high rate of growth in exports is associated with periods of undervalued currencies. A major share of the difference in export performance between the two countries can be explained by differences in real exchange rate policy. Tanzania has maintained an undervalued real exchange rate for a long time and as a result, performs better in terms of export supply and diversification. However, export expansion achieved through undervaluation raises the rate of inflation for Tanzania. Tanzania managed to maintain an undervalued real exchange rate through the accumulation of reserves and a high rate of inflation.