Econometric Analysis of Exchange Rates on Current Account Adjustments in Rwanda

In this work, we use the Vector Auto-Regression (VAR) model to analyze the determinants driving the exchange rate and current account balance of Rwanda, based on BNR quarterly macroeconomic time series data from 2000 Q1 to 2020 Q4. The trade balance is the dependent variable and the real effective exchange rate, GDP per capita, trade openness, trade conditions and Foreign Direct Investment (FDI) are the explanatory factors. The data were transformed into natural logarithms. According to our findings, all variables at I are stationary, which means that there is a long-run relationship between the cointegrating variables. The results of the linear model show that the real effective exchange rate has no impact on the trade balance in the short run but improves the trade balance in the long run. In addition, Granger causality and impulse response analyzes are used to study the dynamics of exchange rates and current account adjustments. Examining the VAR impulse responses for Rwanda, we detect external demand and supply shocks. We also provide evidence of spillover effects from Rwandan demand shocks and central interest rate policy shocks. This study recommends to policymakers that the devaluation of the Rwandan franc improves the trade balance in the long run, all things being equal, whereby an increase in Foreign Direct Investment (FDI) in Rwanda could lead to increased Rwandan economic investment, which would improve Rwanda's current account balance. However, it must be noted that the increase in the volume of foreign direct investment in Rwanda also increases imports and repatriation