Discussion Paper No. 10 of 2001 on Kenya's Exchange Rate Movement in a Liberalized Environment: An Empirical Analysis

Abstract

With globalization has come increased emphasis on an outward- looking and a market-oriented economy. Consequently, the 1990s were associated with a greater degree of liberalization of the financial, foreign exchange and domestic goods markets in Africa. Liberalization of the foreign exchange market in Kenya was gradual- from a fixed exchange rate regime to crawling peg before a flexible or floating exchange rate regime was adopted in the 1990s. This paper analyses factors that have influenced exchange rate movements since the exchange rate market was liberalized in 1993. Despite the policy change, empirical studies explaining exchange rate movements in this period are still scant. Furthermore, the existing studies on Kenya have concentrated on applying the traditional theoretical models based on the interest rate and purchasing power parities. This paper adopts a general empirical specification of the exchange rate equation encompassing the interest rate and price differential, as well as current account balance and net external inflows to explain the exchange rate movements in the 1990s.