Is Currency Devaluation Appropriate for Improving Trade Balance in the WAMZ Countries?

The paper examines the appropriateness of devaluation in improving trade balance in the six WAMZ countries. The motivation is largely derived from the need to reverse the deteriorating external sector of these countries which has become worrisome particularly from the latter half of 2014 on the backlash of slump in commodities prices and tight global monetary condition. The study employs descriptive analysis, granger causality technique, and Vector Error Correction Model (VECM) to analyze the impact of devaluation on trade balance in these countries. Two other control variables, domestic and global output, are included in the model to capture the impact of domestic and global shock while the data covers the period 1980–2014. The trend analysis reveals considerable volatility in real exchange rate in all the countries with the exception of the Gambia while there is a virtual absence of co-movement between devaluation and trade balance in all the countries. All the series are integrated to the first order while Johansen cointegration test indicates the existence of long run relationship among the variables employed in the study.

Results of the normalized long run model indicates that the coefficient of real exchange rate is positively significant in only Liberia while it is negatively significant in the Gambia only. Real exchange rate is not significant in the remaining four countries, suggesting that devaluation may not lead to an improvement in trade balance in the WAMZ countries except probably in Liberia. Results from the models further suggest that external condition like expansion in global output tends to have positive impact on trade balance though the effect is not significant in all the countries. The variables are virtually not significant in the short run models for all the countries while the vector error correction term is suggestive that the impact of shock to trade balance does not wane rapidly. The study recommends, among others, that devaluation may not be the most appropriate policy option to improve trade balance in these countries while these economies should endeavor as much as possible to improve the export content of Gross Domestic Product in order allow local economic condition drive trade balance.