Does unregulated exchange rate asymmetrically affect trade balance? An empirical evidence from Somalia

Somalia has been a stateless nation for over two decades, where government institutions have been destroyed and malfunctioned, including the central bank. Consequently, this ruled out the control and regulation of the money supply and exchange rate by the central bank. This study investigates the effect of unregulated exchange rates on the trade balance in Somalia over the period 1984-2018. Using the nonlinear ARDL model, the results show the presence of asymmetric long-term effects of unregulated exchange rates on the trade balance. The study finds that currency depreciation worsens trade balance both in the long- and short-run, while long-term currency appreciation has a significant impact on trade balance but significant positive short-run effects on the trade balance. Overall, the study confirms the absence of the Marshall-Lerner condition and the J-curve effect, validated by several econometric methodologies for robustness. Our study suggests that reforms in the exchange rate system and monetary policies can restore the credibility and stability of the Somali shilling, which can boost trade and investment. Somalia has been a stateless nation for over two decades where government institutions destructed and became malfunctioning including the central bank. Consequently, this ruled out the control and regulation of money supply and exchange rate by the central bank. The informal unregulated exchange rate market causes serious problems to the Somali economy. Specifically, it constantly increases the inflation rate by raising the price of imported goods given that Somalia is a highly import-dependent country. Additionally, the unregulated exchange rate depreciation does not only raise the price of imported goods, but it also erodes the purchasing power of the low-earning workers who receive their salary in Somali Shillings-thereby causing many households vulnerable to multidimensional poverty. This paper investigates the effect of unregulated exchange rates on the trade balance in Somalia over the period 1984-2018. Using the nonlinear ARDL model, the results show the presence of asymmetric long-term effects of unregulated exchange rates on the trade balance. The study finds that currency depreciation worsens trade balance in both the long- and short-run, while long-term currency appreciation has no significant impact on trade balance but has significant positive short-run effects on the trade balance. Our study suggests reforms in the exchange rate system and monetary policies restore credibility and stability of the Somali shilling which can boost trade and investment.