Experimental

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CHAPTER SIX

SUMMARY AND CONCLUSION

The conclusion of the research is organized into three sub sections. Summary of findings are presented in subsection one, lessons for policy in sub section two. While limitation of the research and area for future research are discussed in sub section three.

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It is against this background that this study has focused on exchange rate behaviour on each of the components of the balance of payments in Sierra Leone.

The analysis presented evidence on the behaviour of exchange rate changes on the overall balance of payments, the overall current account balance and its components-trade balance (exports and imports), the financial account balance and the capital account balance for the period 1970-2010. The study also examined the impacts of key macroeconomic variables such as domestic GDP, foreign GDP, money supply, consumer price index, treasury bearer bonds‘ rates, trade openness and world price index, amongst others on the performance of the balance of payments over these years.

Also, considering exchange rate being a price that influences largely international trades and consumer price index, also being a price but manipulates essentially both domestic trade and consumption, it could be well thought-out that both prices share some levels of relationship. The study was, therefore, extended to assess the response of consumer price index to exchange rate depreciation, which literature had referred to as the pass-through effect.

In an attempt to finding answers to these interactions, a structural macroeconomic model, derived from the elasticity, absorption and monetary theoretical frameworks to BoP determination, was estimated. The model was disaggregated into Current Account Balance (CAB), Financial Account Balance (FAB), Capital Account Balance (KAB) and the consumer price index.

The study employed an autoregressive distributed lag bounds testing approach to cointegration using both quarterly and annual data to determine the dynamic (the short-run and long-short-run measured by elasticities) effects of exchange rate on the key variables.

These elasticities were then used to determine the time path of the changes in the CAB and BoP, as postulated by the J-curve experience and the Marshall-Lerner condition. The data used for the estimations were mainly collected from the International Financial Statistics of the IMF.

Prior to the econometric analysis, the following were completed:

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i) analysis of the country‘s exchange rate policies and development in the balance of payments. Trend analyses of the relationship between exchange rate and each of the components of the balance of payments were critically considered. Further examinations on exchange rate and the sub components (trade balance-exports and imports) of the current account balance were also considered in the analysis.

ii) in order to have an in-depth knowledge of the research, review of the accessible literature that relate to exchange rate and the balance of payments were segregated by components of the balance of payments. From the review, exchange rate behaviour influences all the three components of the balance of payments but at varying degree with the current account being highly receptive to exchange rate movements, while financial and capital account balances responses are relatively stumpy. In addition to exchange rate depreciation, growth or increases in macroeconomic fundamentals such as gross domestic GDP, and foreign countries‘

GDP, world price index, among others have a tendency to positively influence the positions of the balance of payments and its components. Also reviewed, was exchange rate pass-through to domestic price, which was found to be incomplete but exceedingly higher than 70.0 percent for economies that are greatly import dependent in nature, of which developing countries dominated the list.

The key findings from the empirical analyses conducted showed that:

From the estimated coefficients, exchange rate had both short-run and long-run effects on the overall balance of payments. The effects of exchange rate on the components of the balance of payments, however, differed considerably from each other. While the response of current account balance to exchange rate depreciation in both the short-run and long-run demonstrated evidence of the J-curve phenomenon and the Marshall-Lerner condition, the financial account balance and the capital account balance showed no such responses. Exchange rate movements have a stake in determining the outcomes of the country‘s current account balance. This finding is supported by other studies completed for both developing and developed economies (Baharumshad et al., 2004; Kandil, 2009;

Bahmain-Oskooee and Satawatananon, 2011; Ali and Anwar, 2011).

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Fluctuations in exchange rate are a significant determinant of the financial account balance. Variability in exchange rate signals instability of a country‘s macroeconomic fundamentals, resulting in a reduction in financial inflows in the form of investment. This fluctuation has the tendency of increasing financial outflows, which may further worsen the country‘s financial account balance. The results, however, showed that, as exchange rate depreciated, the country experienced a positive net financial inflow. Reasons for such outcomes are: most of the domestic investments during the period were in the areas of mining, agriculture and construction where labour cost and acquisition of locally produced raw materials are cheap for foreign investors relatively to their home companies located abroad, other than in Africa. Any depreciation of the local currency could leave foreign investors with adequate amount of local currency for almost the same amount of foreign currency to meet their expenditures. Also, the civil war could be used to explain the inflow of more foreign investment during the period. The artisanal³⁸ diamond mining continued to attract foreign investment. Due to the war, it was difficult for the central government to monitor the registration and activities of investment in this sector. Hence, the proceeds were not adequately accounted for during the period. Similarly, there was no significant relationship between exchange rate depreciation and capital account movements. This could be attributed to the followings during the period: the capital account was mostly driven by aid from other countries³⁹ in the form of logistics for government‘s operations, training of military and police personnel, medical aid, food aid, educational materials, financing of programmes and projects proposed in the Poverty Reduction Strategy Papers (PRSP: 1 and 2), and the financing of HIPC initiative projects.

Funds for the financing of all these capital projects greatly depended on policies other than exchange rate movements.

On the part of exchange rate pass-through to consumer prices, even though the degree of pass-through was found to be incomplete with a coefficient of 0.80 for Sierra Leone, it was significantly higher than those found for other developing countries, whose coefficients are around 0.70 or less (McCarthy, 2000; Frimpong and Adam, 2010; Bwire,

38 Surface and easy to mining diamond rather than the Kimberley mining, using less expensive tools such as shovels, pick axes, and cutlasses, among others.

39 Such as Britain, USA, France, China, UN (WFP, UNICEF, WHO), DFID, among others.

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et al., 2013). This result means that about 80.0 percent of depreciation in the exchange rate is swiftly passed onto consumer prices. The implication is that disproportionate pass-through is inflationary and has the tendency to exacerbate the general living condition if not curbed with the right policy instrument(s).