How Exchange Rate Changes Affect Trade Balance in Ghana

Abstract

In international commerce, a steady exchange rate has been touted as a positive indicator for all economies. It increases investor trust and allows global market participants to make realistic business forecasts. Despite the adoption of multiple regimes, Ghana's exchange rate has seen significant depreciation. The literature on trade have paid particular attention to the link between trade balance and exchange rate but failed to include certain relevant variables such as FDI and inflation which this study believes can influence changes in the trade balance. This research estimated the effect of exchange rate on trade balance in Ghana by including these relevant variables that extant studies have ignored. It used yearly data from the World Bank Development Indicators from 1980 to 2019 in a Vector Error Correction (VEC) model and concludes that increases in exchange rate has a short run and long run negative effect on trade balance confirming the established fact that depreciation adversely affect the trade balance of Ghana. However, inflation and FDI were shown to have a positive and significant influence on Ghana's trade balance. The study therefore calls for improved policies and actions to earnestly reduce imports, encourage exports and strengthen the value of the cedi.