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Aid inflows and the real effective exchange rate in Tanzania

  • Li, Ying
  • Rowe, Francis
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    Tanzania is well placed to receive a significant increase in aid inflows in coming years. Despite the potential for the additional aid inflows to raise income levels in the country, increasing them may bring about structural changes in the economy that may be unwelcome. One such change is an appreciation of the real exchange rate that leads to a contraction of traditional export sectors and a loss of export competitiveness. This paper employs a reduced-form equilibrium real exchange rate approach to explain movements in Tanzania's real effective exchange in recent decades. Particular attention is paid to the relationship between aid inflows and the real effective exchange rate. The authors find that the long-run behavior of the real effective exchange rate is influenced by terms of trade movements, the government's trade liberalization efforts, and aid inflows. Positive terms-of-trade movements are associated with an appreciation, periods of improving trade liberalization are associated with a depreciation, and increases in aid inflows are associated with a depreciation in the real effective exchange rate. Although the last result is non-standard, it is not empirically unique and does have theoretical underpinnings. A detailed analysis of this relationship over the last decade shows that the Bank of Tanzania's response to aid inflows is likely the main reason for the finding.

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    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 4456.

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    Date of creation: 01 Dec 2007
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    Handle: RePEc:wbk:wbrwps:4456
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    1. Christopher Adam & David Bevan, 2004. "Aid and the Supply Side: Public Investment, Export Performance and Dutch Disease in Low Income Countries," Economics Series Working Papers 201, University of Oxford, Department of Economics.
    2. Ronald MacDonald & Luca Antonio Ricci, 2003. "Estimation of the Equilibrium Real Exchange Rate for South Africa," IMF Working Papers 03/44, International Monetary Fund.
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    5. White, Howard & Wignaraja, Ganeshan, 1992. "Exchange rates, trade liberalization and aid: The Sri Lankan experience," World Development, Elsevier, vol. 20(10), pages 1471-1480, October.
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    8. International Monetary Fund, 2003. "The Equilibrium Real Exchange Rate in a Commodity Exporting Country; The Case of Russia," IMF Working Papers 03/93, International Monetary Fund.
    9. Elbadawi, Ibrahim A. & Soto, Raimundo, 1994. "Capital flows and long-term equilibrium real exchange rates in Chile," Policy Research Working Paper Series 1306, The World Bank.
    10. Cashin, Paul & Cespedes, Luis F. & Sahay, Ratna, 2004. "Commodity currencies and the real exchange rate," Journal of Development Economics, Elsevier, vol. 75(1), pages 239-268, October.
    11. Nilsson, Kristian, 1999. "Alternative Measures of the Swedish Real Effective Exchange Rate," Working Paper 68, National Institute of Economic Research.
    12. Sebastian Edwards, 1987. "Exchange Rate Misalignment in Developing Countries," UCLA Economics Working Papers 442, UCLA Department of Economics.
    13. Kiguel, Miguel & O'Connell, Stephen A, 1995. "Parallel Exchange Rates in Developing Countries," World Bank Research Observer, World Bank Group, vol. 10(1), pages 21-52, February.
    14. Janine Aron & Ibrahim Elbadawi & Brian Kahn, 1998. "Determinants of the real exchange rate in South Africa," CSAE Working Paper Series 1997-16, Centre for the Study of African Economies, University of Oxford.
    15. Volker Treichel, 2005. "Tanzania's Growth Process and Success in Reducing Poverty," IMF Working Papers 05/35, International Monetary Fund.
    16. Mwanza Nkusu, 2004. "Aid and the Dutch Disease in Low-Income Countries; Informed Diagnoses for Prudent Prognoses," IMF Working Papers 04/49, International Monetary Fund.
    17. Ghose, Devajyoti & Kharas, Homi, 1993. "International competitiveness, the demand for exports and real effective exchange rates in developing countries," Journal of Development Economics, Elsevier, vol. 41(2), pages 377-398, August.
    18. Christopher Adam & David Bevan, 2003. "Aid, Public Expenditure and Dutch Disease," Economics Series Working Papers WPS/2003-02, University of Oxford, Department of Economics.
    19. Bazoumana Ouattara & Eric Strobl, 2008. "Foreign Aid Inflows And The Real Exchange Rate In The Cfa Franc Zone," Economie Internationale, CEPII research center, issue 116, pages 37-52.
    20. Howard White, 2005. "Dollars, dialogue and development: an evaluation of Swedish program aid," Development and Comp Systems 0511012, EconWPA.
    21. Luci Ellis, 2001. "Measuring the Real Exchange Rate: Pitfalls and Practicalities," RBA Research Discussion Papers rdp2001-04, Reserve Bank of Australia.
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