Abstract

Whether exchange rate devaluation improves or worsens the trade balance has been an interesting and important area of research for economists and policymakers. This study attempts to identify the effect of real exchange rate on the trade balance of Sierra Leone from 1980 to 2017. A model of trade balance was estimated by first examining the time series properties and estimating an ARDL model in the context of the Pesaran-Pesaran method of bounds testing for cointegration. The explanatory variables used are: real exchange rate, real gross domestic product growth, absorption, export, import, real effective exchange rate volatility, rate of absorption and foreign income. The main finding is that there is a long run relationship between trade balance and the model variables, with a positive effect of real exchange rate on the trade balance. On the other hand, real effective exchange rate was found to have a negative effect on the trade balance. However, real exchange rate volatility was found to have no impact on the trade balance in both the short and long run. Based on the empirical findings therefore, policymakers should adopt measures to boost local productivity, which include measures to boost competitiveness through export substitution models, creation of economic zones, and increased subsidies for local industries. These include continued efforts to abate inflation from the monetary policy direction and from the direction of structural policies, including the need to boost agricultural output in order to stabilise the nominal exchange rate by reducing imports of goods that can be produced home.