Effect of oil price volatility on trade balance in sub-Saharan Africa.

What is it about?

Crude oil is an essential part of every economy and it constitutes a significant percentage of energy for households, firms and government to perform functions such as heating, production and transportation. Since crude oil is important for these economic agents, the volatility of their prices has serious implications not just for the individuals, but also for various macroeconomic activities. The volatility of crude oil price is noted to be influenced by the activities and cartel behaviour of the Organization of Petroleum Exporting Countries (OPEC), political instabilities and natural disasters. Crude oil price volatility is an important driver of trade balance of economies. The risk associated with high oil price volatility is that it causes uncertainty that can lead to a reduction in international trade flows for oil exporters and importers. In this paper, we estimated the effect of crude oil price volatility on trade balance across 34 sub-Saharan African (SSA) countries using Pooled Mean Group (PMG) and Common Correlated Effect Pooled Mean Group (CCEPMG) estimators for the period January 2004 to December 2017. The findings revealed that crude oil price volatility exerts a negative effect on the trade balance of SSA countries. We further demonstrate that inflation, interest rate and exchange rate are significant transmission channels for oil price volatility to impact trade balance. We suggest that policymakers hedge, as well as, adopt price-smoothing schemes to minimise the volatility of oil prices on trade balance. Again, countries should adopt an inflation-targeting regime to ensure the stability of the general price level. Finally, central banks of the respective countries should apply a combination of foreign exchange market interventions and interest rate changes to reduce the effect of oil price volatility on their trade balance.

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Photo by Timothy Newman on Unsplash

Photo by Timothy Newman on Unsplash

Why is it important?

We estimated the effect of oil price volatility on trade balance of sub-Saharan Africa (SSA) by dividing the countries into oil-exporting and importing countries in addition to the overall SSA perspective. Secondly, we explored the transmission channels of oil price volatility on the trade balance in SSA, which prior literature failed to exclusively examine. Our findings show that crude oil price volatility negatively affect the trade balance of SSA countries. We further demonstrate that inflation, interest rate and exchange rate are significant transmission channels for oil price volatility to impact trade balance.

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