The Effects of Exchange Rate Depreciation on Trade Balance in Rwanda

The study sought to investigate if the currency depreciation improves trade balance in Rwanda. The study adopted a two-country imperfect substitute model developed by Rose and Yellen. The model defines trade balance as a function of real exchange rate, domestic income and foreign income. A dummy variable was included in the model to capture the impact of exchange rate transition regime on trade balance. Annual time series data from the period 1980 to 2015 were used in the study. The findings depicted that real exchange rate does improve trade balance in the short-run though it does not improve trade balance in the long run. The study also concluded that exchange rate transition does not affect trade balance in the short-run. The implication of the study findings is that exchange rate depreciation in not a sustainable way to correct trade deficit in the long run. The government of Rwanda should not solely rely on currency depreciation so as to improve trade balance. The Governmentof Rwanda should rather focus on improving domestic output by adopting proper strategies to enhance output led growth in order to reduce trade deficit.