Effects of a Devaluation on Trade Balance in Uganda: An ARDL Cointegration Approach

Obtaining a trade surplus, an increase in exports over imports, is a major economic indicator and one that developing economies strive to obtain. The devaluation of a country’s currency is expected to be one way to obtain the trade surplus, by making imports expensive and exports cheap in the domestic country. This paper investigates the effects of a devaluation on the trade balance in Uganda in both the short run and long run. We consider two major approaches to trade balance improvement- the absorption approach and the elasticity approach. We employed an autoregressive distributed lag model (ARDL) approach to predict the long-term and short-term outcomes of a possible devaluation of Uganda’s currency using gross domestic product as a proxy to income, real exchange rates and trade balances, which are the ratio of exports to imports. Our results suggest that incomes significantly affect trade balances in the long run and short run, while real exchange rates were found to only affect trade balances in the short run.