Determinants of Ethiopian Trade Balance: Vector Error Correction Model (VECM) Approach

Abstract

Trade balance is one core component of national income of countries especially in the present times on which every nation have open economy and foreign interaction. It may be in positive or negative depending on the trading and economic power of the nation. For instance Ethiopia has a negative trade balance for the previous two decades, implies that export of the country could not cover the import expenditure. This indicates that the proportion between export and import is always less than one. There are different factors which result into having as such circumstance. This study tried to assess the main determinants of the trade balance of Ethiopia by considering ratio of export and import as an approximation to trade balance. The study implements error correction model to analyze a time series data from 1981-2011, collected from World Bank. The long-run co-integration result shows that GNI per capita, domestic inflation and trade dependency of the country have negative and significant integration with the ratio of export to import. Given this, world oil price inflation has positive and significant effect on the ratio. The vector error correction model of the short-run regression shows that the previous year ratio (Export/Import), elasticity to import, previous year world oil price, agricultural growth and previous year GNI per capita have positive and significant effect on the speed of adjustment of the long-run trend of the ratio. Given this, elasticity of export, previous year inflation and current year GNI per capita affects the speed of adjustment negatively and significantly. The ECM result shows that the speed of adjustment of the deviation from the long-run trend line is 91%, which indicates that Ethiopian economic system is responsive for each policy measures.