The Impact Of Real Exchange Rate On Madagascar’s Trade Balance

Abstract

This study examines the impact of the real exchange rate on Madagascar's trade balance from 1984 to 2021 using a Vector Error Correction Model (VECM). The results highlight a long-term cointegration relationship between the variables in the model. The error correction term is negative and significant at -0.16, indicating that it takes over six years for the trade balance to return to its initial state after a shock. Long-term results show that all coefficients are significant. The trade balance is positively influenced by foreign income and the real effective exchange rate, but negatively affected by national income. Specifically, a depreciation of the Malagasy real effective exchange rate improves the trade balance. Conversely, a rise in national income deteriorates the trade balance.

In the short term, the trade balance depends on its past values and responds to the real exchange rate and foreign income with a two-period lag. A short-term improvement in the trade balance leads to a deterioration in the following period due to the income effect from increased export speeds. Additionally, an increase in foreign income worsens the trade balance and a  depreciation in the exchange rate deteriorates it.