The impact of balance of trade, FDI, exchange rate and inflation on the balance of payments

What is it about?

This study analyzes the impact of a set of macroeconomic variables including the balance of trade, FDI, exchange rate, and inflation on the balance of payments (BOP) of Afghanistan using quarterly data from the second quarter of 2004 to the fourth quarter of 2020. The paper uses the Vector Error Correction Model (VECM), and Johansen co-integration test for analysis, and provides comparable literature to other least-developed and low-income developing countries. The findings reveal that balance of trade (BOT), foreign direct investment (FDI), and exchange rate are significant determinants of Afghanistan’s BOP in the long run. More specifically, BOT and FDI positively impact the BOP, whereas the effect of the exchange rate on the BOP is found negative. Yet, inflation has an insignificant impact on the BOP. Though all variables have an insignificant impact on the BOP in the short run, the relevant policy measures ought to consider improvement in BOT, promoting FDI, and exchange rate stability to ensure synchronized improved BOP and economic growth.

Featured Image

Photo by Jakub Żerdzicki on Unsplash

Photo by Jakub Żerdzicki on Unsplash

Why is it important?

The novelty of this paper includes (1) it examines the BOP of a country about which there is hardly any study available in this area of literature in a reliable source. (2) This paper has used a combination of monetary and non-monetary indicators for the empirical analysis. (3) this study provides analogous literature to other LDCs and low-income developing countries. Hence, the main purpose of this study is to empirically investigate the impacts of trade balance, FDI, exchange rate, and inflation on the balance of payments. It creates analogical literature for the LDCs and other small economies, which are vastly dependent on international trade, predominantly imports. Accordingly, it draws relevant policy initiatives to help improve the BOP performance of Afghanistan.