The effects of currency devaluation on Malawi’s trade balance : testing the Marshall-Lerner and J-Curve

Abstract

Developing countries like Malawi often utilize currency devaluation to mitigate ongoing trade deficits and foreign exchange imbalances; yet, its efficacy remains ambiguous. The research examines the impact of currency devaluation on Malawi's trade balance, highlighting the applicability of the Marshall-Lerner condition and the presence of a J-curve effect. The study assesses short-term and long-term dynamics using annual time-series data from 1978 to 2023, applying the Autoregressive Distributed Lag (ARDL) methodology and the Error Correction Model (ECM). The ECM findings demonstrate that the real effective exchange rate (REER) adversely affects the trade balance in the short term, validating the initial decrease anticipated by the J-Curve hypothesis. The REER exhibits a positive and strong correlation with the trade balance over the long term, suggesting an eventual adjustment. The aggregate price elasticities of exports and imports (0.067) fall below unity, refuting the M-L condition and indicating inelastic demand. Macroeconomic indicators such as trade openness and GDP/Capita growth benefit the trade balance, while inflation and external debt have mixed effects. These findings imply that devaluation is not sufficient but must be supplemented by other policies. The study concludes that while devaluation has the potential to improve trade performance in the long term, its success in Malawi will depend on structural reforms to increase export competitiveness and reduce import dependence. Policymakers are advised to diversify trade, invest in productive capacity, and maintain macroeconomic stability for long-run external balance and sustainable development.