Effect of foreign exchange rate volatility on the purchasing power of Uganda shilling

Abstract

The study was to assess the effect of instability of foreign exchange rates on the purchasing power of a Uganda shilling. Other objectives were to; determine the stability of foreign exchange rates of certain currencies in Uganda, determine the purchasing power of a Uganda shilling, determine the relationship between the interest and inflation rates and purchasing power of a Uganda shilling. Therefore, this study focuses on the specific needs that are supposed to be done so as to stabilise the currency of Uganda and improve on its purchasing power. The data used in this study was secondary data and it considered all goods and services traded with the Uganda shilling. The data was downloaded from the data base of the World Development Indicators data base and the period 1994 to 2020 was considered for analysis. Exports of goods and services (current US$) were used to measure the foreign exchange rate Uganda shilling. Purchasing power parity (PPP) theory, as based on in the analysis, states that states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries. This means that the exchange rate between two countries should equal the ratio of two countries’ price levels of a fixed basket of goods and services. The univariate analysis proved that the GDP, PPP (current international $) are trended upwards between 1994 and 2020, Exports of goods and services (current US$) are trended upwards between 1994 and 2020, The data shows that there existed high fluctuations in inflation (consumer prices) over the last sixteen years (1994-2020) in Uganda, the Interest rate spread (lending rate minus deposit rate, %) has been unstable and exhibits a stationary movement in the range of 8-14 over the years (1994-2020). The correlation matrix indicated that there is a strong correlation between exports and PPP of a coefficient (0.987) and some slight correlation with interest rates (-0.2746). The correlation of PPP with interest rates was minimal (-0.01s). Exports are Significant predictor of PPP since P<0.05(0.000). A unit increase in exports is associated with an average increase in PPP by 13.277. Inflation and interest rate are insignificant predictor of PPP since P>0.05. It was noted that in order to increase the PPP of a Uganda shilling the level of exports has to be increased and current data about the exports of goods and services, inflation rate, interest rate needs to be considered so as to ascertain the covid-19 impact on PPP of a Uganda shilling