Uganda's equilibrium real exchange rate and its implications for non-traditional export performance

"Pursuit of an exchange rate policy that promotes the competitiveness of exports would be greatly facilitated if the policy maker were able to establish the level of misalignment of the exchange rate and thereby try to correct for it. The motivation of this study for Uganda was therefore to derive the equilibrium exchange rate path, determine the levels of misalignment of the exchange rate and assess their impact on the performance of nontraditional exports. Estimating the equilibrium real exchange rate (ERER) involved: (a) estimation of the real effective exchange rate (REER) by the cointegration and the error correction mechanism (ECM) approaches, (b) filtering transitory factors from the "fundamentals" using the Hodrick-Prescott filter approach and the Elbadawi moving average (MA) methodology, and (c) estimating the ERER using the permanent components of the fundamentals. We find that the magnitude of misalignment, derived as the deviation of REER from ERER, greatly reduced during the period 1991-1999, when the exchange and payments system was liberalized as part of the overall improved macroeconomic management. Further, given that over-valuation of the exchange rate in excess of 15% hampers non-traditional export performance, our results suggest that the exchange rate policy should aim at minimizing over-valuation and, in fact, albeit the inflation objective, over-depreciate REER to boost non-traditional export competitiveness. An explicit estimate of the equilibrium exchange rate is therefore an important variable in exchange rate policy and export competitiveness debates"--African Economic Research Consortium web site.