Exchange Rate Regimes, Import Prices and Foreign Reserve Holdings in Africa

Abstract

In this study, we examined dynamic interaction between exchange rate regimes, import prices and foreign reserve holdings in developing countries. Monthly data for the study were obtained on five African countries from 1980M1 to 2020M12. Recognizing that our sample of nations may not be homogenous due to unobserved characteristics of the individual countries such as, economic size, or differences in financial strength, we modelled reserve holding following P-ARDL specifications of Pesaran, Shin & Smith (1995) which recognizes the MG and PMG modeling in error correction configurations. The Hausman test reveals that MG was more efficient compared to PMG. To check robustness of our MG estimates, we had an alternative GMM specification. The GMM estimation was also necessitated to overcome simultaneity biases and endogeneity problems that characterized OLS estimation of our P-ARDL model. Findings showed that exchange rate regime is a significant positive contributor to the volume of reserve holdings while import prices negatively influences reserve holdings. Relatively, study reveals negative contributions of cost of holding reserves, and inflation towards declining reserve holding in selected countries of Africa is highly significant in both SR and LR. Nevertheless, significant heterogeneity exists amongst countries as regards speed of adjustment following disturbances in SR reserve holding to LR convergence. Nigeria had the fastest speed of 61% compared to Angola, Kenya, South Africa, and Egypt with 49%, 20%, 50%, and 19% respectively. Differences in economic strength, economic size (GDP), government factor, political size, financial depth, etc. of countries could have accounted for the difference in adjustment speed. Our MG estimates were found robust to a GMM specification. The study concludes that there is a dynamics interaction between exchange rate regime, import prices and foreign exchange reserves holding. We so recommended that African countries should strategically implement policies to reduce their inflation rates, dependence on import, effectively manage exchange rate regime so that they can achieve higher volume of external reserve holdings that will lead to a reduction in their import prices.