Real exchange rates, trade balance and capital flows in Africa

We analyze the intertemporal causal relationships between the real exchange rate and trade balance and cross-border capital flows in Africa. We use annual data of nine major African countries for the period 1993–2009. Through panel VAR techniques, we document some causality from real exchange rates to cross-border flows of African countries. Results however differ amongst the three kinds of flows examined and are not uniform across different country clusters. Our findings lend support to the classical balance of trade theoretical view in which the net effect of a depreciation of the domestic currency is an improvement in the domestic country's balance of payments position in the short-run.

► We investigate the intertemporal causal relationships between the real exchange rate and trade balance and cross-border capital flows in Africa. ► We document some causality from real exchange rates to cross-border flows of African countries, with stronger effects documented between exchange rates and trade balance and direct investment flow, respectively, than portfolio investment flow. ► These causalities are not uniform across the different sub-regions of the continent. ► Our findings support the classical theoretical view in which the net effect of a depreciation of the domestic currency is an improvement in the domestic country's balance of payments position in the short-run.