Effect of exchange rates and tariffs on terms of trade in Kenya

Purpose – This study investigates the effect of exchange rates and tariffs on Kenya’s terms of trade (ToT) between 2001 and 2021. It addresses a gap in empirical literature concerning the interaction between these trade variables and ToT, particularly in the context of Kenya’s structural economic transitions and exposure to external shocks. Methodology – An explanatory research design was adopted using annual time series data. The study applied the Autoregressive Distributed Lag (ARDL) model and Toda-Yamamoto Granger causality testing to evaluate both the short-run and long-run impacts of exchange rates, tariffs, exports, and imports on ToT. Diagnostic tests for multicollinearity, normality, and autocorrelation were conducted to validate model robustness. Findings – Granger causality results indicated that exchange rates, tariffs, exports, and imports significantly influence ToT, with bi-directional causality observed for all except exports. The ARDL model showed strong overall fit (R² = 82%) but failed to find statistically significant long-run effects from any single trade variable. In the short run, exchange rate depreciation significantly improved ToT, while import growth had a marginally negative effect. Exports and tariffs demonstrated limited immediate influence despite their predictive relevance. Conclusion – Kenya’s ToT dynamics are most responsive to short-term exchange rate adjustments and import levels, with limited long-run determinacy from individual trade variables. The findings underscore the need for a flexible exchange rate regime, smarter tariff policy aligned with industrial goals, and export diversification. Coordinated macroeconomic and trade strategies are vital for insulating Kenya’s trade performance from external volatility and enhancing its global competitiveness. Keywords: Terms of trade, exchange rates, tariffs, ARDL, Granger Causality