The Effect of Selected Macro-economic Variables on Exchange Rates in Kenya

Abstract

Purpose – This paper sought to establish the effect of selected macro-economic variables on exchange rates in Kenya. The selected macro-economic variables for this study were interest rates, inflation rates and trade flows.

Methodology – The study was modeled as a descriptive survey. A data collection sheet was used to collect secondary data from the published bulletin and other publications by Central Bank of Kenya and Kenya National Bureau of Statistics for a period of ten years between 2006 and 2015. The data was examined using descriptive, correlation and regression analyses.

Findings - Results of the study showed that interest rate had a positive correlation coefficient of 0.446 with exchange rate, Inflation rate and exchange rate had a correlation coefficient of negative 0.395 while the Level of aggregation of trade flows had a correlation coefficient of positive 0.829 to the exchange rate. The value of R square was 0.745, a discovery that 74.5 percent of the deviations in exchange rates in Kenya occurred due to changes in interest rate, inflation rate and trade flows at 95 percent confidence level. The significance value obtained was less than p=0.05 implying that the model was statistically significant in predicting how the macro economic variables of interest rate, inflation rate and trade flows affect exchange rates in Kenya.

Implications - The Kenyan shilling has been depreciating in value over the years implying a weakening of its purchasing power in the international markets. Policy makers should come up with policies that will contribute to reversing this trend. Managing the prevailing levels of inflation, interest rates and trade flows will be key as they have been found to significantly affect exchange rates.

Value - The study will act as a guide to various banking sector policymakers key being the Central Bank of Kenya and the Treasury in formulation of the policies which will manage exchange rates and spur growth and profitability in this sector. The monetary policy decision makers can innovatively formulate foreign exchange strategies that ensure that the exchange rate in the financial market at any time do not negate investments in the economy.

Key Words: selected macro-economic variables, exchange rates in Kenya