The Effects of Currency Devaluation on the Bilateral Trade Balance of Sudan: Cointegration and Error-Correction Modeling

Abstract

The purpose of this research paper is to investigate the effects of exchange rate, income and money supply on the trade balance of Sudan over a fifty-year period from 1970 to 2020. The empirical model for this investigation is developed using a cointegration approach and error-correction technique to specifically examine the effects of currency devaluation on the trade balance of Sudan with its major partners. The bounds test shows that the variables of interest are bound together in the long-run. The associated equilibrium correction is significant, thus confirming the existence of a long-run relationship. Moreover, to analyze the dynamic interactions of the variables included in the estimated model, variance decomposition is employed. The study results from the variance decomposition show that innovations in foreign income contribute highly to the forecast error variance of the trade balance compared with other explanatory variables in the short-run. In contrast, the domestic money supply contributes highly to the trade balance compared with other variables in the long-run. A key finding of the study suggests that the devaluation of Sudan’s currency is not an appropriate step toward improving the country's trade balance position.