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CHAPTER ONE
INTRODUCTION

1.1 Background of the study!

Coffee is the most important cash crop in Uganda. The Uganda Coffee development Authority (UCDA) estimates that 500,000 households distributed over two-thirds of the country depend on coffee production as an important source of Income. Coffee production creates employment for an even larger number of people, as hired farm labor and in businesses such as processing, input supply, trading, and transport. In the coffee market year ending in September 2001, at historically low world market prices, Ugandan coffee exports generated 104.8 million US dollars (UCDA 2001). Coffee’s share of total export revenues has declined dramatically in recent years, from 66.8 percent average in 1991-95 to 31.2 percent in 2000, because of the world coffee price slump and, to a° lesser extent, the growing importance of nontraditional exports such as fish products, cut flowers, cattle hides and electrical current (UBOS 1999 & 2001). Coffee is mainly grown by smallholders with an estimated average coffee farm size of 0.58 hectares (UCDA 2000). Uganda produces both Robusta and Arabica coffees, with Robusta accounting for 85 percent of export volumes and 76 percent of export revenues in 2001. Domestic consumption is estimated at less than 5 percent of production. Uganda produces around 3 percent of the world’s traded coffee and 9.1 percent of all Robustas (ICO export data .from 2001).

Exchange rate refers to the price of a unit of foreign currency in terms of the domestic

currency.

Exchange rates like prices of other commodities are influenced by the market expectation of future events and factors of demand and supply.

Exchange rate is very important since it allows the conversion of the country’s currency into another country which leads to facilitation of international trade for the purchase of goods and services and the transfer of funds between countries. It also allows price comparisons of similar goods in different countries. In general the price difference

between goods that are to be traded between countries and where they are sourced or
shipped, hence exchange rate is a significant factor that influences the competitiveness of
agricultural goods and the profitability of farmers.

In Uganda, the government adopted a floating exchange rate in November 1993, partly to improve the incentives to exporters by removing the implicit taxation of exports. resulting from an overvalued exchange rate and related rent-seeking activities. Since then, the exchange rate for the shilling to the dollar has been flexible and at times very volatile. However, there are mixed views regarding the effects of exchange rate on

Uganda’s agricultural primary commodity exports.

Following the’ liberalization of the exchange rate and interest rates, improvements in’ terms of trade exerted significant appreciation pressures on the exchange rate during the period 1994-1996. Thereafter a strong depreciation of the local currency ensured between August 1997 and July 2003.

The depreciation pressures also coincided with the unwinding of the coffee boom and removal of controls on the capital accounts. However, the stability observed from January 2004 and in some cases a slight appreciation of the local currency suggests that there is an increased confidence in the performance and management of the economy.

The appreciation pressures were partly caused by increased private transfers, exports of goods and services and private capital inflows in addition to the large donor flows.

Producers of agricultural commodities for exports raised concern about possible loss of

.

competitiveness owing to the strengthening of the local currency against the US dollar.

Despite the observed decline in interest rates during the same period, it is not possible to conclude that these were able to offset the exchange rate appreciation due to difficuties faced by agricultural commodity producers in accessing credit from commercial banks.(Egesa 2007).

Uganda has an active foreign exchange policy since 1996. Uganda has steadily moved
from maintaining a single fixed exchange to a dual exchange rate regime (1982-1986)
and finally to a united free floating market which determined exchange rate from 1991 to
date(Kasekende).
There is an occasional central bank intervention to check out the rapid fluctuation in the
rates arising from transitory factors namely; bank of Uganda intervention and sterilization
action in the inter foreign exchange market (IFEM), Bank of Uganda (2002),

1.2 Coffee export performance of Uganda

Uganda’s coffee exports during the month of January 2011 fetched US $ 29.98 million, 19.2 percent up compared to what was realize in 2000. In contrast, there was an 18.3% drop in volume of export from 263,014 60-Kilogramme bags (|5,78l tonnes) in January 2010 to 215,180 bags (12,911 tones). The drop was to Robusta quantities, which fell by 23.9 percent but Arabica was 4.3 percent. Arabica quantities continues to show a positive trend from 181,621 bags in Oct 08/Jan 09 to 217,680 bags in 2010 and 242,344 bags in 2011, which is

attributed to improved agronomic practices in response to good farm-gate prices. On the

contrary, the share of Robusta continues to exhibit a downward trend, largely due to a shift in weather pattern, especially Robusta areas, with prolonged droughts resulting in outbreaks of pests – mealy bugs, twig borers.            .                   .

The coffee export performance of Uganda for the last eleven years is summarized in the

table below

UNIT  ~RATES(S)~
V^tLUE

(USS/Kg)

Table 1.1: Coffee export performance per year
YEAR                    QUANTITY~(6F~VALUE(S)
Kg Bags)

4

Source: Uganda Coffee Development Authority annual report

1.3 Statement of the research problem

Uganda pursued.an active exchange rate policy since 1996 which is a unified free floating

market determined exchange rate with occasional central bank intervention. This was

adopted to reduce inflation immediately withoi

t any adverse side effect on output, the

current account or the real exchange rate.

The exchange rate in Uganda has often been  fluctuating over time due to market

expectations of future events and factors of demand and supply.

This therefore will prompt the researcher to assess the effects of exchange rate fluctuation

on coffee exports. The study will therefore provide a clear proof of the effects of

exchange rate fluctuation on the value of agricultural commodities exported like coffee.

1.4 Research objectives

1.5 General objective

To analyze the effect of exchange rate fluctuations on coffee exports in Uganda.

1.6 Specific objectives

2009. To establish the quarterly exchange rates for the study period 1999-2009.

2009. To establish the quarterly coffee export value for the study period 1999-2009.
      iii. To establish the effect of exchange rate on the price of coffee exports for the
      period 1999-2009

1.7 Research hypothesis

Ho:Exchange rate has no effect on the value of coffee exports. HarExchange rate has an effect on the value of coffee exports.

1.8 Scope of the study

The study was concerned with Uganda’s economy in regard to the effect of exchange rate fluctuation on her coffee exports. The study covered the period between 1999 and 2009 for the variables of coffee exports value and the exchange rates of the US dollar and=

1.9 Significance of the study.

The output is to be used by policy makers and regulators concerned with coffee exports in restructuring efforts to strengthen the export sector.

The output is to provide an explanation to the derrfand and supply behavior in
Uganda’s context and thereby contributing to the empirical economic literature in
Uganda. The output is to provide solutions to the government under which it will use them in
policy making and implementations.
The output of the study is to benefit other academicians and scholars who wiii be
studying on the area of exchange rate fluctuations on agricultural commodities and
other related areas.
CHARPTER TWO;
LITERATURE REVIEW

2.1 Introduction

This section will comprise of previous study made by different researchers on the effect
of exchange rate fluctuation on Uganda’s coffee exports and will be done in reflection of
the objectives of the study.

2.2 Effects of Exchange Rate.

Sajjabi(1994) emphasizes that the right leve

of exchange rate is the most critical decision

in an open economy. An undervalued exchange rate depresses the standard of living and
results in current account surplus. Whereas an overvalued exchange rate artificially raises
the standard of living above the level of productivity and finances it by incurring external
debt.

Campbeel S.T and Kracan (1999) noted that exchange rate policy has been intimately related to .other .macro economic policies.;

Abbot 2001 shows that exchange rate variability is an” insignificant factor for exporters. On the otherhand, another group of studies provide evidence that exchange rate variability is an important negative factor for exporters (Sukar ad’Hassan, 2001)

Henstridge and Kasekende, 2001 argue that “although sub-sequent periods of exchange rate have taken place, the overall performance of the foreign market as a way to
CHARPTER TWO;
LITERATURE REVIEW

2.1 Introduction

This section will comprise of previous study made by different researchers on the effect
of exchange rate fluctuation on Uganda’s coffee exports and will be done in reflection of
the objectives of the study.

2.2 Effects of Exchange Rate.

Sajjabi(1994) emphasizes that the right leve

of exchange rate is the most critical decision

in an open economy. An undervalued exchange rate depresses the standard of living and
results in current account surplus. Whereas an overvalued exchange rate artificially raises
the standard of living above the level of productivity and finances it by incurring external
debt.

Campbeel S.T and Kracan (1999) noted that exchange rate policy has been intimately related to .other .macro economic policies.;

Abbot 2001 shows that exchange rate variability is an” insignificant factor for exporters. On the otherhand, another group of studies provide evidence that exchange rate variability is an important negative factor for exporters (Sukar ad’Hassan, 2001)

Henstridge and Kasekende, 2001 argue that “although sub-sequent periods of exchange rate have taken place, the overall performance of the foreign market as a way to
determine the exchange rate and allows foreign exchange to have been good enough for it not to have been called”.

Friedman, 1953 and Johnson, 1969 argues that flexible exchange rates are beneficial to the economy as they promote trade and overall macroeconomic stability and chose shortrun fluctuations in the exchange rates have no effect on trade volumes. On the other hand, some economists argue that partly due to market imperfections particularly in least

developed countries, hedging is both imperfect and very costly as a basis for avoiding

exchange r|sks (Mundell, 2000).

Sherzod, (2007) ascertains that a vast amount of empirical studies have been conduced within and” across the countries to reveal whether exchange rate fluctuation causes movements in trade volumes, particularly these studies investigate this issue from a point of total trade as well as from the perspective of export and import discretely.

A   number  of diversity   studies   have   been   implemented   regarding   exchange   rate fluctuations vis-a-vis different macroeconomic indicators. The exchange rate fluatuation is directly influenced by several macro variables, such as demand and supply for goods, services and investments. Different growth and inflation rates in different countries change in relative rates of return among others. The present floating rate has been affected by previous real and monetary disturbances. Expectations about current events and future events are also important factors due to the large influence it has on exchange rate fluctuation.

Backman, (2006) states that instability can also arise from overshooting behaviours
which occur when the current spot rate does not equal to a measure of the long-run
equilibrium calculated from a long-run model. If this behaviour arises because the
financial market is not working correctly, high exchange rate does not imply high
transaction costs,

The results of the different studies however show that the impact of the exchange rate in

the monetary policy flame work remains debatable depending on it’s the   effects on

domestic inflation, the source of shocks, credibility, volatility of capital flows and
financial and structural reforms undertaken, Hojlger (2006). However, it has been
generally argued that countries put much emphasis on the exchange rate in their monetary
policy frame work.      .

Munro and Spencer (2004) made a study on the changes in the reserve bank of New Zealand’s policy and it showed that exchange rate played a crucial role during the disinflation phase in 1988-1993 when direct pass-through effects from the exchange rate

were strongest and best identified the channels of monetary policy. This implied that weakening of exchange rate pass-through in an environment of low and stable inflation led to a shift in interest rate channels and the influence of the output gap.

2.3 Effect of exchange rate on coffee exports

Bruk (1992) asserts that the expansion of exports has been a major concern to the policy makers. Through trade, countries are able to access inputs they need to develop, fostering specialization and increasing factor productivity. Exports seem to play a prominent role
in this process as evidenced by the experience of the industrialized countries. Hamza (1994) points out from the international trade aspect that portfolio investment aspects are also important. In particular, portfolios including investments in foreign countries are at a risk in the face of volatile exchange rate. The investors’ foreign investment income and proceeds from the sale of their investments are exposed to fluctuations in the exchange rates of the host country. Changes in stock prices can therefore be related to exchange rate changes.

Klaassen 1999 focuses on industrial countries with a high proportion of manufactured

.
exports  and  that there  is  insufficient  evidence  from  studies  focusing  on  specific

agricultural primary commodity dependent economies such as those in sub-Saharan
Africa. He further suggested that there is need to focus on developing countries with high
– time-variant exchange rates. There are also relatively few studies undertaken at the
individual commodity level.              ‘

Following Aron (1994) and Ayugu (1995). the supply of exports is specified as a function

of relative price and relative domestic production.

Froot etal (1995), Smith etal (1993) and Lessard (1984) observed that exchange rate is

responsible for the revenue inflows to the country and so its fluctuations influence cash

Lessard and Sharp (1984) and Kasekende (1995) argue that exchange rate affecys cometitiveness of exports which is a source of income. The effect on purchase side

affects the sales side and ultimately the exchande gain (Glen, 1996; Ciaessens, 1993). On out flows, the excnage eate affects the cost structure as it is regarded as a nominal anchor to domestic prices. The combined effects yield the variation in net cash in flows.

2.4 Effect oi exchange rate on coffee prices

Jorion (1990) refers to the link between exchange rate and stock prices as “foreign exchange exposure”. Kasekende (1995) and Sajjabi (1994) found out that exchange rate

as a policy instrument has been used by governments to influence economic activity on

two fronts. First: exchange rate acts as a nominal anchor of domestic prices, affects the
domestic price of imported inputs and the shilling price of consumer goods. Secondly; it
impacts on the local prices and competitiveness of exports and therefore the profitability
of exporters.

Kasekende (1995) and Sajjabi (1994) further urged that exchange rate like any price
influences both the demand and supply of goods and services. Dprdunoo and Njunken
(1995) advance the view that for developing countries that are heavily indebted and
import dependent, exchange rate is the key determinant o*f trade balance position as well
as external competitiveness.   ‘

Krugman and Thaler (1994) argue that limited information flow in the market affect the setting of exchange rates since it depends on available information in the market. This is a problem because it tends to reduce efficiency and competitiveness in the market and it
can promote collusion  by the-large  dealers  in  the market thus  inhibiting healthy”’
competition.

an efficient means of communication and general experience
imply that dealers lack confidence dealing with each other, which finally retards the

improvement of trade hence leading to a trade balance deficit (as it a world bank No.

15081,r995).

The exchange rate fluctuations affect the cost structure. Glen (1996) and Claessens (1993) points out that in a market determined exchange rate regime, the nominal exchange rate ceases to be a nominal anchor for domestic price. The costs of imports are

‘   ‘

subject to market conditions and; can lead to an instable cost conditions. The authors observe that fluctuations in commodity prices can destroy a firm’s competitiveness through affecting adversely both cost of its inputs and the price of output.

CHAPTER THREE

METHODOLOGY

3.0 Introduction

This chapter was concerned with the research design, methods, procedures, study population and sample size, methods of Data collection, instruments and sources of data, measurement of variables. Data analysis procedures, presentation of data and limitations

of the study.

3.1 Research Design

on

The study necessitated the use of quantitative method since it was to be based

numerical values and therefore an experimental design was used. Both descriptive and analytical studies were employed. Analytical studies were emphasized since most of the data was of secondary nature and mainly inductive in nature in order to build up theories.

3.2 Data type and source

The study depended on quantitative data of secondary nature. Data was obtained from respective records qf the coffee export values in dollars which was recorded quarterly from 1999-2009 as well as the real exchange rates with respect to US dollar. Secondary sources were used to gather data and these included; Ministry of Finance. Planning and Economic Development, Uganda Coffee Development Authority, Ministry of Trade. Tourism and Industry and Uganda Bureau of Statistics.

3.3 Area and population of the study

The study was conducted for the period of 1999-2009

3.4 Data collection methods

The study was to use secondary data .It was obtained from various existing literature
fro™.libraries of UBOS, MFPED, UCDA, MTTI, World Internet Web, and Statistical
Abstracts.

3.5 Data analysis

It was quantitative using statistical packages of Ms-Excel and Eviews. Use of tables like

frequency tables, bar-charts was essential in the presentation. The model that the researcher used was Y=po+plXl+p2X2+U-Where; Y is the value of coffee exports

XI is the foreign income

X2 is exchange rate
J3o is a constant

pi is the income elasticity of exports

P2 is the price elasticity of exports

jj is the error term                .

3.6 Anticipated limitation

The researcher may encounter the following limitations. i.      Time and other financial problems may limit the researcher from getting all the

information required.
ii High transport costs incurred in movements in the process of gathering the
information from different sources
CHAPTERFOUR

PRESENTATION, ANALYSIS AND DISCUSSIONS OF THE FINDINGS

4.0 Introduction;
This chapter gives the outcome and findings of the study that was carried out to examine
the effect of exchange rate fluctuation on Uganda’s coffee exports. These are represented
in form of tables and graphs. Comparisons were made between variables; the amount of
coffee exports (Y), foreign income (XI) and the exchange rate (X2).

4.1 Unit Root Test Unit root test were carried out in order to es ablish the order of integration of the variables since most macro Economic variables are non stationary. In addition, for inferences to be valid, all the variables in the model to be regressed must be of the same order of integration. Testing for the order of integration enables avoidance of spurious integration in order to investigate data characteristic, Augmented Dickey Fuller (ADF). The test was used because it relaxes the assumption that the error term is un-eorrelatecl. The process involved testing hypothesis that a time series is stationary against the

alternative that, it is non stationary. Failing to reject the null hypothesis suggests that the data series is non stationary and has to be differenced at least once in order to make it

stationary. This is because the data variable is difference stationary.