Asymmetric impact of exchange rate on trade balance in Ethiopia: Evidence from a non-linear autoregressive distributed lag model (NARDL) approach

Ethiopia has persistently pursued exchange rate devaluations to address its trade deficit and the structure of the economy, a strategy supported by the United Nations and economists. However, the effectiveness of this policy shift has sparked prolonged debate among scholars, exacerbated by divergent findings regarding the effect of exchange rates on trade balances. This study investigates the asymmetric effect of the real exchange rate on Ethiopia’s trade balance from 1992 to 2022. Employing the Non-linear Autoregressive Distributed Lag Model (NARDL), the research challenges the prevalent assumption of a linear (symmetric) association between exchange rates and trade balances in Ethiopian studies. Results reveal asymmetric effects of the exchange rate on the trade balance in both the short and long run, suggesting that exchange rate depreciations have varying implications for trade balances compared to appreciations of similar magnitude. Both real exchange rate depreciation and appreciation demonstrate statistically significant and positively asymmetric effects on Ethiopia’s trade balance across temporal dimensions. Specifically, a 1% exchange rate depreciation corresponds to a 0.843% and 0.856% improvement in the long-run and short-run trade balance, respectively. Furthermore, a 1% appreciation of the exchange rate is associated with a 15.079% and 15.02% enhancement of the long-run and short-run trade balance, respectively. The study underscores the importance of considering non-linear models of asymmetries in policymaking to inform more effective interventions.