Effect of remittances on exchange rate volatility in Uganda

Abstract

The objective of this study was to examine the effect of Remittances on Exchange Rate Volatility in Uganda for the period of 1999 to 2013. Quarterly data was employed. In order to confirm that the variables were stationary, Unit root tests such as ADF, PP and KPSS were employed. The ADF, PP and KPSS tests confirmed that Exchange rate volatility, Remittances and Trade Openness where not stationary at levels but became stationary after taking their first differences. Interest rates, on the other hand, became stationary in levels. Using the Lag Order selection criteria based on the maximum value of the Likelihood ratio function, a Vector Auto Regressive (VAR) structure with 2 lags was confirmed. Johansen cointegration tests based on Maximum Eigen test (P-value of 0.018) and Trace test (P-value of 0.009) confirmed a unidirectional relationship between the variables under study. Results from the long run model indicated a significant relationship between the variables (p=0.000). Furthermore, an Error Correction Model was estimated to examine short run dynamics of the Exchange Rate Volatility. Results from the short run model indicated that 51.3% of the variations in Exchange rate were explained by Trade openness and Interest rates. The coefficient value on remittances was positive but insignificant. Analysis was also carried out to find out the contribution of variables to shocks in the Exchange Rates. Variations in exchange rate volatility were explained by itself at 71.50%, Remittances at 12.38%, Trade openness at 8.94% and Interest rates at 7.156%. Therefore, study findings recommended that policy and decision makers need to pay attention to exchange rate stability and in order to achieve this, macroeconomic fundamentals have to be controlled.