| | | Title | Exchange Rate Misalignment Determinants and Performance of Portfolio and Direct Asset Flows to Kenya: A Threshold Analysis | | Author | Benson Kiriga and Jacob Nato | | Subject | Exchange rate misalignment in Kenya and its impact on portfolio and direct investment flows. | | Date of Publication | 2024 | | Publisher | Kenya Institute for Public Policy Research and Analysis | | Number of Pages | 50 | | Keywords | Kenya, exchange rate misalignment, real exchange rate (RER), Fully Modified OLS (FMOLS), Threshold Autoregression (TAR), Hodrick-Prescott (HP) filter, portfolio investment, direct investment, macroeconomic variables, structural factors, fiscal policy, monetary policy, investment flows, economic growth, macroeconomic stability | | Abstract | This study aimed to estimate the misalignment of Kenya’s exchange rate, identify its drivers and assess its effect on portfolio and direct asset flows. Thus, the Fully Modified OLS (FMOLS), Threshold Autoregression (TAR) models, and HodrickPrescott (HP) filter were employed for analysis, using data from 1980 to 2023. From the results, there was evidence of mild exchange rate misalignment in Kenya, within a range of ± 4.0 per cent. The real exchange rate for Kenya is a stable function of a set of well-defined macroeconomic variables, implying that both macroeconomic and structural factors affect the exchange rate. Analysis of threshold effects showed that exchange rate misalignment negatively affected direct investment assets, whereas the effect on portfolio investments was positive—likely because Kenya has had only small magnitudes of misalignment. A 1.0 per cent increase in the Real Exchange Rate (RER) misalignment led to a decline in direct investment flows, and this depended on the cut-off level of the misalignment, while misalignment yielded a small positive impact on portfolio flows. Based on the study findings, three recommendations stand out. First, for proper exchange rate management, there is a need to ensure coherence in fiscal and monetary policy and work towards ensuring a stable exchange rate for Kenya. Second, the currency should be managed in a way that it does not get extremely misaligned beyond safe thresholds, as excessive deviations can be detrimental to the country’s investment flows. Third, the country should work towards ensuring a steady flow of both direct and portfolio investments, which can be leveraged for economic growth and development. This would be supported by macroeconomic stability. | | Filesize | 1389416 MB | | File Format | PDF | | [ View / download original document ] |
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