The Monetary Approach to Exchange Rate Determination : An Application to Sudan for the Period (1978-2006)

Abstract

The exchange rate is considered as one of the macroeconomic indicators that affects other economic variables. Sudan, like any other developing countries is suffering from many economic problems; one of these is the deterioration of its currency value during the period 1978- 2006, so what economic forces lie behind this deterioration? This research examines the validity of the monetary model of exchange rate determination as an explanation of the Sudanese Pound-United States Dollar relationship during the period under study. The methodology used in this study is descriptive and analytical in nature depending on primary and secondary data; the Ordinary Least Square (OLS) technique was used for the analysis purposes, using the E.views software package. The main hypotheses are: -The increase in the money supply differential had led to increase in the exchange rate i.e. it depreciated. - The increase in the GDP differential had led to decrease in the exchange rate. - The increase in the inflation differential rate had led to increase in the exchange rate. - The increase in the interest differential rate had led to decrease in the exchange rate . It is found that, the estimated results tend to support the hypothesis that the exchange rate depends on the monetary fundamentals. The finding showed that the money supply and the income differentials coefficients conform to the theoretical model and the hypothesis of the study. Considering the inflation rate differential, it is found that the increase in the expected long run inflation had led to the depreciation of the exchange rate. Also it has been found that the interest rate is not one of the monetary determinants of the exchange rate in Sudan. According to the above findings it is recommended that: - Policy instruments are required to reduce and eliminate balance of trade deficit and stabilize the exchange rate. - Monetary authorities should target substantial reserves and keep money supply growing at an appropriate rate to ensure sufficient growth and to maintain internal and external stability. - Support should come further from non-oil related foreign direct investment to provide external financing source for productive activities beyond the country capabilities. - Packages of incentives or measures that could develop the Sudanese equity market to encourage foreign indirect investment in local stocks the thing which could help in building considerable amount of foreign recourses.