Estimation of Threshold Effect of Kenyan Shilling Exchange Rate on Rwandan Economy: A Semiparametric Model Approach

The exchange rate is an important variable in international trade which is used as a parameter to determine a country’s international competitiveness and indicates the position of the country’s economy. A change in the exchange rate of the Kenya shilling has an impact on Rwanda’s economy. To study this variation, some researchers use linear regression models which do not allow them to assess the threshold of the kenya exchange rate around which the channels through which a fall or increase in economic growth could be determined. The use of linear models is also a modeling limitation, as it imposes a predetermined form on the functions linking exogenous variables to dependent variables. To correct these two aspects, we have proposed a semiparametric threshold model to measure the threshold effects of changes in the exchange rate of the Kenya shilling on the Rwandan economy. This paper examines the threshold effect of the Kenyan shilling exchange rate on the Rwandan economy using yearly data from 1996 to 2018. Using a semiparametric model, the results of the imports, exports, and GDP threshold models revealed that the Kenyan shilling exchange rate is 7.78, 7.52, and 7.39 Rwanda’s value, respectively, and has a significant positive effect on the Rwandan economic growth, which gives credence to the relevance of threshold level. Thus, paying adequate attention to the maximum of the threshold values estimated by the Kenyan shilling exchange rate would lead to a better growth rate of the Rwandan economy. An increase of the value of Kenyan shilling by one Rwandan franc leads to a more rapid increase of the Rwandan economy through GDP, exports and imports when the value of the kellian shiling exceeds these thresholds. Based on these findings, the National Bank of Rwanda should ensure that the Rwandan Franc does not appreciate above its equilibrium level, which can lead to a loss of competitiveness.