Exchange Rate Volatility and Malawi’s Tobacco Exports to The United Kingdom and The United States

Abstract

The availability and sources of foreign currency in Malawi have become the subject of prominent policy debates in the country in the recent past. Malawi, which traditionally relies on agriculture and foreign aid for foreign currency earnings and balance of payments support, has experienced a shortage of foreign currency. It is against this background that this paper examined the relationship between the responsiveness of Malawi’s tobacco exports to the United Kingdom (UK) and the United States of America (US) markets for the period between 1995 and 2011. The objectives of the study were to examine the impact of exchange rate volatility on Malawi’s tobacco export earnings to the UK and the US and to determine and compare the volatility coefficients between the two export destinations. Based on the GARCH modelling, the paper found that exchange rate volatility in Malawi varies over time. When there is market disequilibrium in the long run relationship for both markets, there are differences in the rapidity of adjustments relating to the exchange rate volatility coefficient, but these are not significant. For example, the error correction term for tobacco exports to the US is -0.2389, while the error correction term for tobacco exports to the UK is -0.2341. This means that there is a relatively faster recovery in the disequilibrium for the tobacco exports to the US than that experienced for the UK market. Given these findings, it is important for researchers and policy makers to pursue appropriate exchange rate policies that will promote exchange rate volatility in Malawi, since the results show that exchange rate volatility has a positive effect on tobacco exports. Hence, the monetary authorities should pursue free and floating exchange rate policies to achieve exchange rate volatility. In addition, authorities should pay particular attention to the collusive behaviour of tobacco buyers, in order to avoid price fixing at the auctions.