ARDHI UNIVERSITY

SCHOOL OF SPATIAL PLANNING AND SOCIAL SCIENCES

DEPARTMENT OF ECONOMICS AND SOCIAL SCIENCES

BACHELOR OF ARTS IN ECONOMMICS

DISSERTATION

STUDENT NAME; SALUM SALUM NURU

REGSTRATON NUMBER: 8351/T.2015

TITLE: EFFECT OF EXCHANGE RATE ON MANUFACTURING OUTPUT IN

TANZANIA

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Contents
CHAPTER ONE........................................................................................................................................2
INTRODUCTION.................................................................................................................................2
1.1 Background......................................................................................................................................2
1.2 Statement of the problem................................................................................................................4
1.3 Research objectives..........................................................................................................................5
1.3.1 General objective......................................................................................................................5
1.3.2 Specific objective.......................................................................................................................5
1.4 Significance of the study..................................................................................................................5
1.5 Scope of the study............................................................................................................................5
1.6 Organization of the study................................................................................................................5
CHAPTER TWO.......................................................................................................................................6
OVERVIEW..........................................................................................................................................6
2.1 Overview...........................................................................................................................................6
2.2 Manufacturing sector performance................................................................................................6
2.3 Manufacturing growth and contribution to GDP, a long term trend..........................................7
2.4 Manufacturing investment..............................................................................................................9
2.5 Manufacturing employment.........................................................................................................10
2.6 Manufactured exports...................................................................................................................11
2.7 Exchange rate.................................................................................................................................12
2.8 Exchange Rate in Tanzania...........................................................................................................15
2.9 Foreign Exchange Operations......................................................................................................15
2.10 Exchange Rate Performance at Interbank Foreign Exchange Market...................................16
CHAPTER THREE.................................................................................................................................18
LITERATURE REVIEW...................................................................................................................18
3.1Theoretical literature review.........................................................................................................18
3.2 Empirical literature review...........................................................................................................20
3.2.1 Empirical literature review outside Tanzania......................................................................20
3.2.2 Empirical studies inside Tanzania.........................................................................................21
CHAPTER FOUR...................................................................................................................................22
METHODOLOGY OF THE STUDY................................................................................................22
4.1 Theoretical framework..................................................................................................................22

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 4.2 Model specification........................................................................................................................22
4.3Definition and measurements of variables....................................................................................23
4.4 Hypothesis......................................................................................................................................23
4.5 Data type and sources....................................................................................................................24
4.6 Estimation procedure....................................................................................................................24
4.6.1 Diagnostic test.............................................................................................................................24
4.6.2 Unit root test...............................................................................................................................26
4.6.3 Co-integration.............................................................................................................................27
4.6.4 Vector Error Correction Model.................................................................................................27
CHAPTER FIVE.....................................................................................................................................29
EMPIRICAL RESULTS AND THEIR INTERPRETATIONS.......................................................29
5.1 Overview.........................................................................................................................................29
5.2 Descriptive statistics......................................................................................................................29
5.3 Correlation matrix.........................................................................................................................30
5.4 Unit root test results......................................................................................................................31
5.5 Co-integration test results.............................................................................................................32
5.6 Estimation results of the model....................................................................................................33
5.7 Diagnostic test................................................................................................................................34
5.7.1 Autocorrelation.......................................................................................................................35
5.7: Heteroscedasticity.....................................................................................................................35
4.8 Summary........................................................................................................................................35
CHAPTER SIX........................................................................................................................................36
CONCLUSION, POLICY IMPLICATIONS AND RECOMANDATIONS...................................36
6.1 Overview.........................................................................................................................................36
6.2 Decisions for Hypotheses of Study................................................................................................36
6.3 Main Findings................................................................................................................................36
6.4 Policy implications and recommendations...................................................................................37
6.5 Limitation of the study..................................................................................................................38
6.6 Further Areas of Study.................................................................................................................38
References................................................................................................................................................39

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 CHAPTER ONE
INTRODUCTION
1.1 Background
The desire of every less developed country like Tanzania is the need to ensure rapid
industrialization. This is in the light of industrialization, the process of manufacturing consumer
goods and creating social overhead capital is a prerequisite for economic development and an
escape route of unemployment, high poverty level, income inequalities, social imbalances while
delivering a high level of welfare, self-reliance, confidence and social harmony for the country
and its citizen. It is logical to say that industrialization is seen as a conscious effort of growing
the manufacturing sector of the economy. Hence, industrial reforms and policies are tailored to
have a strong impact on manufacturing outputs.

The manufacturing sector in Tanzania remains relative small, with the most activities
concentrating on the creation of simple consumer products such as foods, beverages, tobacco,
textiles, furniture and wood allied products. In spite of its declining size, however, the sector
continues to be of considerable importance to the Tanzania economy as is still one of the most
reliable sources of government revenue in terms of import sales as well as for both corporate and
income taxes, accounting for over half of the annual government revenue collection.

The sector has been subjected to several industrial, trade, financial, fiscal, and general
macroeconomic policy reform measures. The measures were intended to correct and improve the
situation as well as spur correct market signals and investment incentives to the manufacturing
and other sectors, increase the level of competition, technical efficiency and stimulate total
productivity. This necessitated the country to move towards sector-led industrialization away
from centralized planning system and industrialization led by parastatals. Developments in the
real effective exchange rate (REER) and improving competitiveness through competition policy
with various strategies like encouraging investments including FDIs, productivity, promoting
exports, and privatization, are among the major measures taken by the country. With time the
reforms have boosted more the non-traditional exports including gold and manufacturing than
traditional exports.

4
The contribution of the manufacturing sector to the overall GDP of the country has averaged 8%
over the last decade, however activities within the sector have been registering an annual growth
of 4% and the sector is currently the third most important to the Tanzania economy behind
agriculture and tourism. In 1986, the Tanzania government made the decision to liberalize trade
and investment policies within the country. As a result of this decision and because they could
not stand up to competition from import manufacturers many firms began to fail. Therefore, with
this in mind, a number of measures were taken to increase both competitiveness of the local
industries and their ability to penetrate the export markets.

Exchange Rate

Most of the analyst, economist and policymakers prefer floating exchange rate system over fixed
exchange rates because floating exchange rate absorbs the variations in foreign markets in a
better way in the existence of an efficient market of foreign exchange(Khan,2014). The
flexible exchange rate system also protects a country from adverse external shocks (Anitha,
2013).

The exchange rate regimes in Tanzania have been influenced through historical government
macroeconomic policy from fixed exchange rate regimes to floating through liberalization in the
nineties. The exchange rates have been characterized by significant fluctuations.

The trend shows that there is a continuously decline of Tanzania currency value since we attain
our independence in 1961 it was 7Tshs per 1 Dollar. The table below shows the trend of
exchange rate.

Table 1.1; show the trend of exchange rate in Tanzania

YEARS 1980 1991 2001 2015 2016 2017

EXCHANG 8.1 219.2 876.4 2100 2236.71 2292

E RATE

Source: WDI DATA (2017)

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The fall of currencies is not only in Tanzania but also it is experienced in other countries
such as India, Pakistan, Poland as well as neighboring countries of East African region these
are Uganda and Kenya, they are experiencing huge depreciations of their currencies against
the Dollar.There has been an ongoing debate on the appropriate exchange rate policy in
developing countries. The debate focuses on the degree of fluctuations in the exchange rate in the
face of internal and external shocks. Exchange rate fluctuations are likely, in turn, to determine
economic performance. In judging the desirability of exchange rate fluctuations, it becomes,
therefore, necessary to evaluate their effects on output growth and price inflation. Demand and
supply channels determine these effects.

1.2 Statement of the problem

Economists and policy makers often refer to exchange rate as a key macroeconomic variable. As
a relative price, the exchange rate plays a critical role in transaction between open economies.
However, the link between the theoretical concept of the exchange rate and its empirical
application is not straight forward one. Two different theoretical views have been put forward
about how exchange rates fluctuations affect output. The first view states that, a real appreciation
of domestic currency lowers the cost of imported raw materials and thus leads to an expansion of
real output (Papazoghou, 1999). While the traditional view states that a real appreciation lowers
international competitiveness, which in turn, lowers aggregate demand. These two conflicting
theoretical views pose an empirical issue and call for empirical test growing economies like
Tanzania.

Musyoki and Pundo (2012) study on the impact of real exchange rate volatility on manufacturing
output: Niger evidence for the period of 1993-2009. Found that Niger‘s RER generally exhibited
an appreciating and volatility trend, implying that in general, the country‘s international
competitiveness deteriorated over the study period, hence, impacting negatively on the
manufacturing output.

Several studies have been conducted on the impact of the real exchange rate on output. Few of
the studies have reported positive effect of devaluation (depreciation) on output (Vo, et al. 2000,
Terence & Pentecost, 2001). Contrariwise, some studies have reported a negative impact of
depreciation (devaluation) on output (Sheeley, 1986; Rogers & Wang, 1995).

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1.3 Research objectives
1.3.1 General objective
i. To examine the effects of exchange rate on manufacturing output in Tanzania.

1.3.2 Specific objective

ii. To examine the trend of manufacturing output
iii. To examine the relationship between exchange rate and manufacturing output

1.4 Significance of the study

The study will be helpful to other scholars in understanding the relationship between exchange
rate and manufacturing output. Also this study will be used by other researchers as a point of
references on their similar or related studies of a such matter. Moreover, the research is expected
to be used and applied in several policy grounds on exchange rate stability specifically in
Tanzanian economy.

1.5 Scope of the study

The case study of this research is manufacturing sector, coverage area for the study will be
Tanzania, and since it is my country then it will be easy to conduct the study. I will use the
secondary data and I expect to collect data from world development indicators data from World
Bank website and data from journals in bank of Tanzania. Stata will be used to run the regression
and to run several test in the study. Furthermore will use on secondary data and it will be
quantitative and qualitative study in nature.

1.6 Organization of the study

This study is organized in six chapters. Chapter one covers an introduction and background to
the study, the statement of the problem, the research objectives, the significance of the study and
scope of the study, The second chapter presents overview of variables in Tanzania, third chapter
cover literature review and fourth chapter covers Methodology of the study, fifth chapter
empirical result and interpretation, and lastly, chapter six presents the Summary of the study,
Conclusions, and Policy implications. After chapter six the dissertation presents References and
Appendices.

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 CHAPTER TWO
OVERVIEW

2.1 Overview
This chapter provides a background on performance of manufacturing sector and exchange rate
in Tanzania. The chapter is organized into two main subsections, one on manufacturing sector
performance and the other is exchange rate.

2.2 Manufacturing sector performance

Tanzania’s manufacturing performance has been low even by comparison to Sub Saharan Africa
countries. The contribution of the sector to GDP has been at 9.0 percent for most years. In the
region Tanzania performance is low compared to Kenya and Uganda for example with 15
percent and 10 percent contribution respectively in the same period. This suggests the challenge
for Tanzania to take-off and transform its economy from traditional agriculture to a modern
economy. The per capita Manufacturing Value Added (MVA) is one of the lowest in sub-
Saharan Africa, and has remained almost the same or dropped during the last fifteen years,
( Semboja, 2010).

Due to this challenge several macroeconomic policy reform measures have been undertaken
since 1986. Initially, the reform programs were part of the economic reforms aimed at reducing
parastatal dominance while improving the use of domestic resources. Their implementation was
supported by structural adjustment loans to facilitate the program and put in place the essential
macro-economic environment, including a sound legal and regulatory framework plus an
institutional base. The Public Sector Reform Commission (PSRC) divestiture program targeted
manufacturing sector, reducing the large number of non-performing parastatal enterprises in
order to eliminate subsidies extended to them. In addition, programs to stimulate private
investment and participation, with a view to stimulating economic growth were pursued.

In collaboration with the private sector, the government launched Sustainable Industrial
Development Policy (SIDP) 1996-2020. The main objective of SIDP was to accommodate the

8
shift from a centrally planned economy to a more market oriented one whereby the private
sector, as an engine of economic growth, was to play a dominant role. The overall mission of
industrial development in Tanzania was spelt out as contributing towards achievement of the
overall national long-term development goals: human development and creation of the
employment opportunities, economic transformation, environmental sustainability and equitable
development. The major economic indicators for the industrial sector were specified as; rate of
growth, value added contribution to GDP, exports and employment. The SIDP had short,
medium and long term policy objectives and strategies.

2.3 Manufacturing growth and contribution to GDP, a long term trend

Overall, the pattern of Manufacturing performance in Tanzania shows volatility over time.
Starting at high growth rate and contribution to Gross Domestic Product (GDP) in the 1960s to
1970s, the sector declined both in terms of growth in the 1980s and importance ever since
(Skarstein and Wangwe, 1986; Szirmai and Lappere, 2001; see Figure 2.1 which shows
performance of Manufacturing sector in terms of both growth and contribution to GDP. Such
“volatility” is typical of a situation where policies are not implemented in a sustainable way or
are inconsistent (UNIDO 2015).

30

25

20

15

10

0
61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15
19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20
-5

-10

-15 Mfg Growth (%) Mfg GDP (%)

Figure 2.1 Long run trend of Manufacturing Performance in Tanzania: 1961-2015

The trend in Manufacturing performance shows typical premature deindustrialization – long
term decline in manufacturing after 1976, relative to other sectors (at a lower level of GDP per
9
capita), with manufacturing not yet reaching the shares of employment and GDP typically
associated with the normal turning point of industrialization).

Table 2.1: Importance of Manufacturing sector in Tanzania: 1964 to 2015

1964 1970 1985 1995 2000 2015 2015

current constant
prices 2007
prices

Agriculture 49.3 41.1 56.6 50.7 45.9 31.4 22.2

Industry 8.1 12.4 10.3 14.7 16.4 21.8 22.4

o/w Mining 2.4 1.3 0.3 1.4 2.2 3.6 3.4

&quarrying

Manufacturin 5.0 10.1 6.9 7.9 7.9 4.2 7.3

g

Electricity+ 0.7 1.0 1.1 1.4 1.5 1.0 0.9

Water -- -- -- 0.2 0.2 0.4 0.6

Construction 2.8 4.9 2.0 3.8 4.6 12.6 10.2

Services 42.6 46.9 33.1 34.6 37.7 46.8 55.4

2.4 Manufacturing investment

Investments in Manufacturing have been made by both Government and private sector, with
FDIs featuring prominently after mid 1990s. The Government played a greater role up to mid
1980s, mainly championing industrialization through created parastatals after 1967
nationalization of private industries.

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In recent past Manufacturing has been a significant recipient of investments. Between 1996 and
2011 Manufacturing projects registered by Tanzania Investment Center (TIC) totaled 2,217
equivalent to 31.8 percent, followed by tourism;:1,727 projects equivalent to 24.8 percent. Value
wise Manufacturing projects accounted for 17 percent of total value of investments, (third to
economic infrastructure, 23.5 percent and tourism, 21.7 percent). See Rwegasira et al, 2016.

2.5 Manufacturing employment

There has been a modest increase in manufacturing employment over the years, though still at
low level compared to employment growth in other sectors (Table 2.2). See also Figure 2.3.

Table 2.2: Manufacturing Employment 2006 and 2014 Compared

Year Number Share (%) Change (%) Annual

growth (%)

2006 434,206 2.61 -

2015 615,323 3.07 0.46% 2.75

Sources: URT 2014 and 2016

The low share of Manufacturing employment is another manifestation of pre-mature de-
industrialization with the share being less than the typical turning point of industrialization which
is ten percent and more.
2.5.1 Labour productivity in Manufacturing
Issue of productivity in Manufacturing sector has been treated at length in other works such as
Szirmai (2001) and Rwegasira et al (2016). The long term trend in employment and Value
Added as shown in Figure 2.3.
It is interesting to note the consistently positive and high level of change in employment, while
Manufacturing Value Added has been changing at low rates. This is an indication of inability to
reduce costs or inability of labour to improve performance.

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 Mfg VA %change Mfg employment %change

Mfg employment %change

350.0% 0.3
Mfg VA %changee

300.0% 0.2

250.0% 0.1
0
200.0%
-0.1
150.0%
-0.2
100.0%
-0.3
50.0%
-0.4
0.0% -0.5
67

69

71

73

75

77

79

81

83

85

87

89

91

93

95

97

99

01

03

05

07

09

11

13
-50.0% -0.6
19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

20

20

20

20

20

20

20
Figure 2.3: Long term trends in Manufacturing Value Added and Manufacturing Employment:
1967-2015

2.6 Manufactured exports

Overall, performance of export of Manufactures shows an upward trend in nominal terms from
USD 13.24 million in 1961 to USD 1,239.6 million in 2014. The same can be said with respect
to shares in total exports and in non-traditional exports (Table 2.4). Period-wise, Ndulu et al
(2001) point out that the share of manufactures in non-traditional exports declined from an
average of 24 percent during 1961-1966 to 16 percent during 1967-1975 before recovering
marginally to 20 percent during 1986-1989.

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Table 2.4 Performance of Manufactured Exports in Tanzania, 1980-2014, Selected Years
Year Manufactured Share in total Share in Non-
exports (USD exports (%) traditional
million) exports (%)

1961 13.24 9.5 24.9

1965 13.80 7.4 19.5

1970 17.50 6.2 11.7

1975 33.13 7.5 14.1

1980 92.79 12.05 25.2

1985 20.11 6.09 12.0

1990 16.28 23.8 48.9

1995 74.89 16.0 36.5

2000 43.10 6.50 11.71

2005 156.1 9.31 11.81

2010 963.9 22.4+ 30.3+

2014 1,239.6 23.31 32.66

2.7 Exchange rate

Exchange rate is the price at which one currency (e.g. the U.S. dollar) can be exchanged for
another currency (e.g. the TZ shilling). In other words, it is the value of another country’s
currency compared to that of your own (Saunders and Cornett, 2012). If for example you are
travelling to Tanzania and the exchange rate for U.S. dollar is 1:1600 TZS, this means that for
every U.S. dollar, you can buy TZS 1600. Theoretically, identical assets should sell at the same

13
price in different countries because the exchange rate must maintain the inherent value of one
currency against
other (Bangudu, 2010).
Again an exchange rate can simply be defined as the price of one nation’s currency in terms of
another currency, often termed the Reference Currency. For example TZS/USD exchange rate is
just the number of Tanzania shillings that one dollar will buy. Exchange rate can be for spot or
forward delivery. A spot rate is the price at which currencies are traded for immediate delivery or
in two days in the interbank market. A forward rate is the price at which foreign exchange is
quoted for delivery at a specified future date (Shapiro, 2006).

2.7.1 Fixed Exchange Rate

It is own currency on the foreign exchange market in return for the currency to which it is
pegged. There are two ways the price of a currency can be determined against other. A fixed or
pegged rate is a rate the government (Central Bank) sets and maintains as the official exchange
rate. A set price will be determined against a major world currency usually the U. S. dollar but
also other major currencies such as Euro, Pound sterling, Yen or as a basket of currencies (BOT,
2009).
In order to maintain the local exchange rate, the central bank buys and sells it. For example, it is
determined that the value of a single unit of local currency is equal to USD 3 the central bank
will have to ensure that it can supply the market with those dollars. Again in order to maintain
the rate, the central bank must keep a high level of foreign reserves (Senni, 2010). Foreign
reserve is a reserved amount of foreign currency held by the central bank that it can use to
release (absorb) extra funds into or out of the market. This ensures an appropriate money supply,
appropriate fluctuation in the market (inflation or deflation) and ultimately the exchange rate.
The central bank can also adjust the official exchange rate when necessary (BOT,
2009).
Central bank can also declare a fixed exchange rate, offering to supply or buy any quantity of
domestic or foreign currencies at that rate. In this case one talks of a fixed exchange rate under
this regime, a loss of value usually forced by market or a purposeful policy action is called
devaluation where as an increase of international value is revaluation. The most stable fixed

14
exchange regimes are backed by an international agreement on respective currency values, often
with a formal obligation of loans among central bank in case of necessity (BOT, 2009).

An extreme national engagement to fixed exchange rates is the transformation of the central bank
in a mere currency board with no autonomous influence on monetary stock. The bank will
automatically print or lend money depending on corresponding foreign currency reserves. Thus
exports, imports and capital inflow (e.g. FDI) will largely determine the monetary policy.
Monetary unions phase out the national currencies in favor of one (new or existing). Some
further countries can target to join and put in place economic and financial policies to that aim,
especially if there are explicit conditions for entering into that monetary area (BOT, 2009).

2.7.2 Floating Exchange Rate

Unlike the fixed rate, floating exchange rate is determined by the private market through supply
and demand. A floating rate is often termed self – correcting, as any differences in supply and
demand will automatically be corrected in the market. Take a look at this simplified model if
demand for a currency is low, its value will decrease, thus making imported goods more
expensive and stimulating demand for local goods and services. This in turn will generate more
jobs, causing an auto correction in the market. A floating exchange rate is constantly changing;
in reality no currency is wholly fixed or floating. In a fixed regime, market pressures can also
influence changes in the exchange rate. Sometimes when a local currency does not reflect its true
value against its pegged currency, a black market which is more reflective of actual supply and
demand may develop (Keyfitz, 2004).

The central bank will often then be forced to revalue or devalue the official rate so that the rate is
on line with the unofficial one thereby halting the activity of the black market. In floating
regime, the central bank may also intervene when it is necessary to ensure stability and to avoid
inflation, however it is less often that the central bank of floating regime will interfere the wholly
process (Senni, 2010). When the exchange rates can freely move, assuming any value that is
private demand and supply jointly established, freely floating exchange rates will be the name of
currency institutional regime. Equivalently it is called flexible exchange rate as well. If the
central bank timely and significantly intervenes on the currency market, a managed floating

15
exchange rate regime takes place. The central bank intervention can have an explicit target for
example in terms of a band of currency acceptable values (Bangudu, 2010).
2.8 Exchange Rate in Tanzania
The reform period (1980s) is notable for the economic recovery programmes supported by
international financial institutions (IFIs) and donors aiming at raising output growth, bringing
down the rate of inflation, restoring external balance and improving social services. Together
with these were trade and exchange rate liberalization. These gradually led to a rapid
depreciation of the Tanzanian shilling. The ultimate aim was to eliminate the multiplicity of
exchange rates (i.e., to unify the foreign exchange market) so as to evolve a market-based
exchange rate and thus overcome inefficiencies associated with administrative allocation of
foreign exchange. These reforms were backed by institutional reforms, particularly in the area of
finance and banking, progressive reduction of quantitative restrictions, and simplification (and
compression) of tariff schedules. The “own funded import” scheme (initiated in 1984) and open
general licence (OGL); (initiated 1972 and reformed in 1988) were instrumental in the gradual
import liberalization. Requirements to surrender foreign exchange earnings of exports were
dropped. Foreign exchange shops (bureaux de change), most of them private, were allowed to
operate beginning in April 1992. Foreign exchange auctions were established in June 1993 to
prepare grounds for an inter-bank market. Exchange rate unification was achieved by August
1993 and implied converging formerly multiple exchange rates into a market based competitive
rate and minimizing allocative distortions and rent-seeking activities. The accompanying
liberalization of trade and payment regimes reduced administrative restrictions on current
account transactions, cost, time and uncertainty related to external transactions. After unification,
the premium on the unofficial (illegal) parallel exchange rate virtually disappeared. In June 1994
the Inter-bank Foreign Exchange Market (IFEM) replaced the weekly auctions. It comprises
Bank of Tanzania, commercial banks and foreign exchange bureaux, and non-bank financial
institutions.8 Though the Tanzania shilling exchange rate is freely determined in the IFEM, the
Bank of Tanzania may occasionally intervene (e.g., in 1999/2000) to build up foreign exchange
reserves to reduce exchange rate volatility. The IFEM and forex bureau rates continued to
narrow, reflecting unification and market efficiency. The foreign reserves position reached 5.6
and 6.1 “weeks of imports” in 2000 and 2001, respectively, compared with less than one week of
imports in the early 1980s.

16
2.9 Foreign Exchange Operations
BOT gradually eased foreign exchange controls after the enactment of the Foreign Exchange Act
of 1992, by allowing the establishment of foreign exchange bureaux in April 1992, introducing
foreign exchange auctions in July 1993, and creating the Interbank Foreign Exchange Market
(IFEM) in June 1994.

The foreign exchange market in Tanzania is composed of the wholesale and retail markets. The
IFEM is the wholesale market, which plays an important role in the determination of the
country's official exchange rate and the provision of funds for the accumulation of international
reserves. Tanzania's trade and exchange system is completely free of restrictions on making
payments and transfers for current account transactions, BOT (2003).

In 2005 Foreign exchange operations were guided by the need to achieve a stable market
determined exchange rate, according to BOT’s Monetary Policy (June 2012). In this respect and
consistent with the price stability objective, BOT continued to exercise interventions aimed at
quelling transitory fluctuations in the exchange rate so that market forces persist to play a greater
role in determining the exchange rate. In addition, two-way quote mechanism was introduced at
the IFEM. Under this arrangement IFEM participants are required to quote two exchange rates:
one at which they are willing to buy, and another at which they are willing to sell, with a
minimum trading lot of 100,000 US dollars. The system assisted to increase transparency in
trading and reduce speculation in the exchange rate movements.

At the end of December 2004, official international reserves stood at 2.3billion US dollars,
equivalent to 8.8 months of imports of goods and services. But over time, the amount swell to
2.7 billion US dollars in February 2008, before raised slightly to 3.6 billion US dollars in
January 2012, which is approximately equivalent of four months of imports , BOT Monthly
Economic Review (May 2012).

Nevertheless, the BOT data shows that gross foreign reserves of commercial banks have
increased from only 780.1 million US dollars in February 2008 to 1.02 billion US dollars in
January 2012, implying that gross foreign reserves of the banking system in Tanzania have
grown from 3.5 billion US dollars in February 2008 to about 4.6 billion US dollars in January
2012.

17
2.10 Exchange Rate Performance at Interbank Foreign Exchange Market
Since the introduction of Tanzania shilling in June 1966, after the collapsing of East African
Currency Board, the domestic currency keeping on sliding—though the biggest swing was in
2011. Figure 1.12, though shows the depreciating trend since 2005, the slope clearly show the
upward swing trend. Tanzania is a net-import economy, where exports are not supporting
imports to create imbalances on favour of exports. In this case depreciation of a shilling raises
the costs of imported goods and services. This could have an adequately meaning if the economy
takes the advantages to exports more goods and services, but unfortunately the country has less
goods and services to export and in most cases sell overseas commodities in raw forms.

1800.00
1600.00
1400.00
1200.00
1000.00
800.00 Series1
600.00
Linear
400.00 (Ser-
200.00 ies1)
0.00
2005 wk 1 2006 wk 102007 wk 192008 wk 282009 wk 372010 wk 46 2012 wk 3

Source: BoT IFEM data

Figure 2.12: Exchange Rates

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 CHAPTER THREE
LITERATURE REVIEW
3.1Theoretical literature review
The monetary and traditional flow theory
The monetary approach to exchange rate determination postulates that the relative supply of the
demand for money between two countries is the basis for the determination of exchange rate. It
views increase in the supply money as being able to generate inflation, hence, resulting in
exchange rate depreciation. The model opines that a situation of falling prices with a given
nominal money supply results in exchange rate depreciation while traditional flow model is
essentially based on the principle of the interplay of demand and supply. The forces of the
market (interaction between demand and supply) determine the rate of exchange. However, when
there is speculation or expectation of a change in the rate of exchange, this could lead to the
disequilibrium even without any change in the initial determined factors. Exchange rate can
adversely affect the ability to import and therefore manufacturing output. Fluctuations in
exchange rate will cause instability in purchasing power and hence, negatively impact on
investment in import of manufacturing inputs. On the other hand, the effect on manufacturing
output and overall income level will also affect investment in import of inputs and invariably the
exchange rate. This is because among the determining factors of the rate of exchange are the
demand for foreign exchange, the supply itself being influenced by an economy’s productivity
level.

The Purchasing Power Parity (PPP) Theory

The Purchasing Power Parity (PPP) simply states that a unit of any given currency should be able
to buy the same quantity of goods in all countries. Many economists believe that the ppp
describes the forces that determine exchange rates in the long run. Accordingly, the nominal
exchange rate between the currencies of two countries must reflect the different prices level in
those countries. PPP, which forms a strong building block of the theory of exchange rate
determination, maintains that there exists a proportional relationship between the exchange rate
of the currencies of two countries and their relative inflation rates. The theory is based on the law
of one price, which explains that, in the absence of trade barriers and transportation costs, spatial

19
commodity arbitrage ensures that the price of any good is equalized across different countries.
The PPP theory can be formulated in two forms: in absolute forms. The absolute form of PPP
asserts that the equilibrium exchange rate equalizes the general purchasing power of a given
income in terms of relative price levels. It thus, relates the level of exchange rate to relative
prices levels. The relative form argues that changes in exchange rate measured from a base
period reflect changes in relative price levels.

The Uncovered Interest Parity (UIP)

The Uncovered Interest Parity is the capital account equivalent of the purchasing power parity.
This forms the central assumption of the Capital Account Monetary Model of exchange rate
determination, which maintains that exchange rate moves in such a way that the expected rates of
return are equalized across countries. This implies that the spot rate and expected value of future
exchange rate, in asset market equilibrium in such a way that investors are indifferent between
the currencies in which they hold assets given the relevant interest rate (rd and rf). The UIP
assumes that capital is perfectly mobile across countries, that is , there are no exchange controls,
no transaction costs, and that investors are risk neutral. This implies that assets denominated in
different currencies are regarded by investors as perfect substitutes. Hence, the law of one price
will hold for asset returns rather than prices of tradable goods. Under this scenario, if the
expected changes in the nominal spot exchange rates reflect that expected inflation rate
differential in two countries which ensure that real exchange rate remains constant, UIP implies
that the real interest rates will be the same in two countries

Katarzyna (2014) said that the theories of the exchange rate began to flourish in the beginning of
1960s. However, despite their large number and considerable diversity, most of them consider
only some selected issues and there are few works carried out, conducting a comprehensive
analysis of the factors influencing the exchange rate levels.

The modern explanation of the long-term exchange rate determination is based upon the theory
of purchasing power parity (PPP) between different currencies that derives its essential validity
from the law of the single price. According to the purchasing power parity theory, in the long
run, identical products and services in different countries should cost the same.

20
According to Dhasmana (2013) exchange rate movement can influence the performance of a
firm in a number of ways, such as through the cost of imported input, export price in comparison
with foreign competitors, or the cost of external borrowing. In general, the theory of Marshall
Lerner condition states that devaluation of a currency is good for the trade balance if the
elasticity of demand for imports in the devaluing nation plus the foreign elasticity of demand for
the nation’s exports exceeds 1.

3.2 Empirical literature review

3.2.1 Empirical literature review outside Tanzania
Several studies have been conducted on the impact of the real exchange rate on output. Few of
the studies have reported positive effect of devaluation or depreciation on output (Vo, et al. 2000,
Terence & Pentecost, 2001). Contrariwise, some studies have reported a negative impact of
depreciation on output (Sheeley, 1986, Rogers & Wang, 1995). All the same, few studies have
argued that real exchange rate may produce negative or positive impact on output in the short run
but neutral in the long run (Edwards 1986, Kamin & Klau,1998).

Opaluwa, Umeh and Abu (2010) examined the impact of exchange rate fluctuations on the
Nigerian manufacturing sector during a twenty (20) year period (1986 – 2005). The econometric
tool of regression was used for the analysis. The finding of this study is that fluctuations in the
rate of exchange are not favourable to economic activities in the manufacturing sector. It was
discovered that the performance of the manufacturing sector was affected by factors such as high
cost of foreign exchange for procuring raw materials and machineries required for production,
availability of financial capital, technological underdevelopment, inadequate socio-economic
infrastructure, shortage of technical manpower and foreign domination; following the
implementation of exchange rate devaluation; the manufacturing sector has not performed any
better because of the influence of the earlier mentioned factors which affect the manufacturing
sector performance.

According to King-George (2013), the effect of exchange rate fluctuations on the Nigeria
manufacturing Sector was set to find out the effect of exchange rate on the Nigeria
manufacturing Sector. Hypothesis was stated to guide the study. To evaluate this hypothesis,
annual time series data on manufacturing gross domestic product a proxy for economic growth,
exchange rate, private foreign investment and manufacturing employment rate were collected

21
from the year, 1986 to 2010. A multiple linear regressions were adopted employing Ordinary
Least Square (OLS) techniques. This analysis yielded some interesting results. From the results it
was observed that exchange rate has no significant effect on economic growth of Nigeria. Also
that dependent variable (Manufacturing Gross Domestic Product) can be controlled by, exchange
rate, private foreign investment and manufacturing employment rate.

3.2.2 Empirical studies inside Tanzania

Lugaiyamu (2015) on his study, a general equilibrium model was built with micro foundations to
capture Tanzania’s unique structure of imports and exports. The model hypothesizes the
numerical value of the real exchange rate is positively related to tax, negatively related to
government consumption, positively related to the expenditure on imports of oil, negatively
related to the earnings from gold exports, negatively related to foreign income and positively
related to natural or long run output

Mwakanemela (2014) conducted a research to investigate the relationship among the

macroeconomics variables such as FDI, trade openess and inflation rate on the manufacturing
export performance of Tanzania from the period of 1980 to 2012. Vector Error Correction Model
(VECM) and Ordinary Least Squares (OLS) regression were employed in the research and the
result from regression analysis indicated that inflation rate negatively impacts manufacturing
performance.

22
 CHAPTER FOUR
METHODOLOGY OF THE STUDY
4.1 Theoretical framework
The monetary and traditional flow theory are the guide of this study. To explain the relationship
between manufacturing output and exchange rate, then money supply and inflation as to be
considered since the change of prices with a given money supply result in exchange rate
fluctuation thus these variable can negatively affect import of manufacturing input and therefore
affect the manufacturing output. Manufacturing output is function of inputs however exchange
rate fluctuations cause instability in purchasing power and hence negatively impact on
investment in import of manufacturing output. Therefore exchange rate affect manufacturing
output.

Therefore; manufacturing output = f (exchange rate)

Also depending on literature review, there are other factor that affect manufacturing output are
included in this model. Example Opaluwa, Umeh and Abu (2010) added variables like financial
capital and private foreign investment.

The model extend to include other factor to exchange rate that affect manufacturing output can
be written as;

Manufacturing output = f (exchange rate, x)

Whereby; x – other variables

4.2 Model specification

The model to be used is linear regression model which will explain the relationship between
dependent variable and the independent variables.

MVA= F (REER, X)

Whereby; MVA- manufacturing value added

REER- Real effective exchange rate

23
 X- Other factors (interest rate, inflation, Money supply, foreign direct investment
and trade openess)

Now the model can be written as follows;

lnMAV =α 0 +α 1 lnREER+ α 2 lnMS+α 3 lnint + α 4 lnFDI +α 5 lnTO +ε t

Where by;

 MAV- Manufacturing value added

 REER- Real effective exchange rate
 MS-Money supply
 INT- Interest rate
 FDI-foreign direct investment
 TO-Trade openness

4.3Definition and measurements of variables

VARIABLE MEASUREMENTS DEFINITION
EXCHANGE RATE This will be measured by real This is the independent variable, it is
exchange rate obtain by using local currency per foreign
currency.
MANUFACTURING It will be measured by The output of all factories in a country
OUTPUT manufacturing value added
INTEREST RATE Is the amount of interest due per period,
as a proportion of the amount lent,
deposited or borrowed
TRADE OPENESS Sum of export plus imports, to Is a measure of economic policies that
country’s gross domestic product either restrict or invite trade btn countries
FOREIGN DIRECT Sum of equity capital, Refers to direct investment equity flows
INVESTMENT reinvestment of earning and other in the economy.
capital
MONEY SUPPLY It will be measured by M2 Total amount of money in circulation in a
country

24
4.4 Hypothesis
The following null hypotheses and alternative hypotheses have been developed in this study.

H0: exchange rate has positive relationship with manufacturing output

HA: exchange rate has negative relationship with manufacturing output

4.5 Data type and sources

The annual time series data of variables covering a time period between 1985and 2016 will be
used in this study, collected from secondary data. These secondary data will be obtain from
source such as Bank of Tanzania (BOT) annual report, World development indicator, Tanzania
data portal and also journal will be used as source of data.

4.6 Estimation procedure

Basing on the nature of data, the objective of study and the theoretical review the following
below are some basic estimation procedures.

4.6.1 Diagnostic test

In the context of time series modelling, it is vital for the researcher to carry out numerous types
of diagnostic tests to make sure that the model does not faces any econometric problems and
make sure that the model must be BLUE (Best, Linear, Unbiased Estimator). Econometric
problem such as autocorrelation, heteroscedasticity, normality problem and last but not least the
model specification problem will normally appear in the model.

4.6.1.1Testing for normality

Normality test is conducted in a research to examine whether the error term is normally
distributed in the model. Jarque-Bera Test is carried out to examine whether the model is
normally distributed. With the assumption of normality, the OLS estimators can be easily
interpreted, for the reason that the linear function of the variables will normally distributed by
itself (Gujarati, 2004).

Hypothesis Statement:

H0: The error terms are normally distributed.

H1: The error terms are not normally distributed.

25
Decision Rule: Reject H0 if p-value is less than level of significance. Otherwise, do not reject
H0.

4.6.1.2 Autocorrelation

According to Zovko (2008), autocorrelation also known as serial correlation or lagged

correlation and it is use to determine the strength of relationship of a variable with its own past
and present values, or in another words, it can explain as correlation of the error term in the
present with the error term in the past. Autocorrelation can happen whether in the time series
data or cross sectional data. Normally autocorrelation problem caused by internal and external.
Internal is due to the distribution of the error term of a true specification of a model and external
is due to the wrong functional form or omitted important variables.

In order to test the autocorrelation problem, Breusch-Godfrey serial correlation Lagrange

multiplier test or Durbin Watson h-test can be used to detect the presence of the problem. But,
normally the LM test will be opt as it has a better explanation on the higher AR model which is
the AR(2) and Durbin Watson h-test is biased for the autoregressive moving average models so it
is a chance that the autocorrelation is underestimated at the first place (Wealliem, 2009).

Hypothesis Statement:

H0: There is no autocorrelation problem in the model.

H1: There is an autocorrelation problem in the model.

Decision Rule: Reject H0 if p-value less than level of significance. Otherwise, do not reject H0.

4.6.1.3 Heteroscedasticity

Heteroscedasticity problem occurs when the error term variance is different or not constant
across the observation or independent variables. If there is a detection of heteroscedasticity
problem, the model should be re-estimate by using the weighted or generalized least square
method. After the re-estimate process, the model will be more efficient to be estimate compared
to the OLS method (Holgersson & Shukur, 2004).

To test for heteroscedasticity problem in the model, the Autoregressive Conditional

Heteroscedasticity (ARCH) Test is carried out.

26
Hypothesis Statement:

H0: There is no heteroscedasticity problem in the model.

H1: There is heteroscedasticity problem in the model.

Decision Rule: Reject H0 if p-value is less than level of significance. Otherwise, do not reject
H0.

4.6.1.4 Model Specification Test

The presence of model specification error in the model is because of the model include any
irrelevant variables. Multicollinearity occur when there are irrelevant variable included and it is
highly correlated with another independent variables in the model, sense that one can linearly
forecast from the others with non-trival degree of accuracy (Molinuevo & Saez, 2014). The
multicollinearity problem is most likely to be take place in most of the time series model. We opt
to use RAMSEY RESET Test to test whether the model contain any specification errors and
correctly specified or not. However, it is noted that Ramsey RESET test can only be used to
check the functional form of the variables whether is correct or not.

Hypothesis Statement:

H0: The model specification is correct.

H1: The model specification is incorrect.

Decision Rule: Reject H0 if p-value is less than level of significance. Otherwise, do not reject
H0.

4.6.2 Unit root test

Unit root test can be classified into 3 types in analyze time series. Dickey-Fuller (DF) unit root
test is used when the error term is uncorrelated. ADF test is used when error terms are correlated
by adding the lagged of ΔYt . Whereas, PP unit root test is a non-parametric method to carry a
serial of correlation in error term (Gujarati & Porter, 2009).

Augmented Dickey Fuller test (ADF)

The ADF model was developed by Dickey and Fuller (1981). Compare to DF test, this test is
conducted in augmented term by the addition of a lagged difference term of dependent variable
27
(ΔYt) in the model (Gujarati & Porter, 2009). As a consequence, the number of sample size will
become larger.

lnMAV =α 0 +α 1 lnREER+ α 2 lnMS+α 3 lnint + α 4 lnFDI +α 5 lnTO +ε t

From the model above, represents to level form of series (MAV, REER, MS, FDI, TO, INT) and
the first difference of the series (∆MAV, ∆REER, ∆MS, ∆INT, ΔFDI, ΔTO). While α0 refers the
intercept term, 𝛼1 is the trend variable. ∆ is the first difference operator, where ε𝑡 refers to white
noise error term.

Under the ADF test, the null of hypothesis is unit root or non-stationary when p-value equals to
zero. While, alternative hypothesis is stationary when p-value do not equal to zero. If the p-value
is smaller than 10%, 5% and 1%, the null hypothesis will be rejected. Otherwise, we do not
reject null hypothesis.

4.6.3 Co-integration
Co-integration defines two variables are not moving in same direction but they are co-integrated.
It indicates the existence of a long term equilibrium relationship between the variables (Granger
and Newbold, 1974). In the concept of co-integration, all variables must be integrated of the
same order and linear combination of non-stationary variables (Gujarati & Dawn, 2009).

Co-integration testing aims to examine whether the non-stationary series is co-integrated or not
co-integrated. Hence, Johansen and Juselius (JJ) Co-integration Test will be applied to
determinate the co-integrating relationship among variables. Johansen (1988) and Johansen and
Juselius (1990) conducted the JJ test to examine co-integration among the nonstationary
variables calculated by observing the ranking of the Π matrix via its eigen values.

4.6.4 Vector Error Correction Model

If our time series variables are not found to be stationary, and have a unit root in level, but are
stationary in the first difference, we will construct a VECM model to overcome it. VECM
provides more efficient test results of co-integrating vectors because VECM is a perfect
information maximum likelihood model. It can test for co-integration in the entire model in a
single step. Furthermore, the variables do not have to be normally distributed in VECM. It is able
to capture the long run equilibrium relationship of time series variables that are co-integrated.
ECT (Error Correction Term) that is used in this method shows how the time series adjusts to

28
disequilibrium, or to put it another way, it is an estimation of the speed of adjustment to
equilibrium of the dependent variable from changes in the independent variables. Engle and
Granger (1987) said that failing to include ECT will lead to misspecified models and inefficient
forecasts.

29
 CHAPTER FIVE
EMPIRICAL RESULTS AND THEIR INTERPRETATIONS
5.1 Overview
This chapter focus on interpret and analyze the estimated results which conducting empirical
result based on the methodology discussed in Chapter four. Firstly, diagnostic checking will be
conducted in order to check the efficiency in model. Next, the level of stationary in time series
variables is determined by using Unit Root test, Augmented Dickey-Fuller (ADF). Then,
cointegration test is applied to observe the existence of either a short run or long run relationship
in the time series variables. After conducted cointegration test only make decision on using VAR
model or VECM model. Last but not least, granger causality test is performed to examine the
causality of the variables used in this paper. Ordinary least square technique is used and also the
STATA Version 14.0 was used so as to obtain the results of the study.
5.2 Descriptive statistics
Before the empirical estimation of the model, data transformation was done to establish
descriptive statistics of the series in level.
Descriptive statistics of the variables used in the study were presented in tables 5.1.

Table 5.1 Descriptive statistics results of data

Statisti LogMS logINT LogFDI logTO
logVA logRER
cs
14.4298 2.97462 62.3146 3.824213
Mean 24.7336 6.6657
Maxim 26.3722 7.7092 16.6361 3.58352 28.8370 4.184962
um
Minimu 23.4043 4.5981 11.4402 2.53370 14.7597 3.511277
m
24.7697 6.9096 14.3024 2.81899 26.6230 3.802204
Median

Std.dev 0.65092 0.8130 1.5416 0.30272 3.7962 0.178270

n
Varianc 0.42370 0.6609 2.3765 0.09164 14.4112 0.031780
e
Source; Authors own calculation using data from appendix 1.
From Table 5.1 show that all variables are normally distributed because median and mean were
very closer to each other.

30
5.3 Correlation matrix
Correlation matrix shows the association between variables either dependent variable with the
independent variables or the independent variables themselves. Also it measures the strength and
direction of the linear relationship between variables. Correlation between variable and itself is
often one (1).

Table 5.2 correlation matrix results.

statistics | logVA logRER logMS logINT logFDI logTO

-------------+------------------------------------------------------
LogVA | 1.0000
LogRER| 0.4635 1.0000
LogMS | 0.5913 0.9595 1.0000
LogINT | -0.4004 -0.6688 -0.7181 1.0000
LogFDI | 0.3240 0.8661 0.8365 -0.5038 1.0000
LogTO | 0.1471 0.0118 0.0830 0.3441 -0.0193 1.0000
Source; Authors own calculation using data from appendix 1.

The correlation analysis indicates only how or to what extent variables are associated with each
other. The correlation coefficient is a measure of linear relationship associated between two
variables. Values of the correlation coefficient are always between -1 and +1. A correlation
coefficient of +1 indicates that two variables are perfectly related in a positive linear sense; a
correlation of coefficient of -1 indicates that two variables are perfectly related in a negative
sense and correlation coefficient of 0 indicates that there is no linear relationship between the
two variables. When a correlation coefficient is greater than +0.5 0r absolute -0.5 it indicates
multicollinearity problem.

Table 5.2 above indicated that there is strong relationship between the some variable, such as
exchange rate and money supply, exchange rate and interest rate, with more than 0.5 coefficient.
Also indicated that there is no strong relationship between the some variables which show there
is no problem of multicollinearity between some variable with less than 0.5.

31
5.4 Unit root test results
Since this study uses time series data, the use of stationary test is necessary. The Augmented
Dickey Fuller test was used to test the stationary of data. So as when data are applied in
diagnostic or regression, they should be only data that are in stationary not only that a unit root
test can help to solve problems in statistical inference that involving time series models.

Table 5.3: Unit root test statistic of variables in levels

test- Order of
Variable statistics p-value integration Remarks
Manufacturing
value added -3.078 0.0028 L(0) Stationary
Exchange rate -6.292 0.0000 L(0) stationary
Broad money -3.113 0.0022 L(0) Stationary
Interest rate -1.284 0.6366 L(0) Non-Stationary
FDI -1.829 0.3661 L(0) Non-Stationary
Trade openness 0.2223 -2.157 L(0) Non-stationary
Source: Computation results of data from appendix 1
From the table 5.4 above, variables are tested for stationary at lag 0 only three variables are
stationary (manufacturing value added, exchange rate and broad money) while others variables
are seen to be non-stationary

32
Table 5.4: Unit root test results

First difference

test-
Variable statistics p-value lag Remarks
LogVA -6.375 0.0000 L(0) Stationary
LogRER -6.292 0.0000 L(0) Stationary
LogMS -5.765 0.0000 L(0) Stationary
LogIR -5.929 0.0000 L(0) Stationary
Logfdi -5.898 00000 L(0) Stationary
logTOP -5.308 00000 L(0) Stationary

Source: Computation results of data from appendix 1

From table 5.5 variables are tested at first difference for the purpose of correcting the non-
stationary variables and all the variables become stationary at this level.

5.5 Co-integration test results

Cointegration test estimate either short run or long run relationship happen in series variables.
Cointegration test will be employed when Unit Root test exists the same order integrated in data
series. In this section Johansen test will be conducted as mentioned in Chapter four. Trace
statistic and Maximum Eigen value will continue in testing the null of cointegrating vector until
the null hypothesis is not rejected. However, Trace statistic only can test until three times. It
cannot be proceed if there is still reject null hypothesis at third times.

33
Table 5.5 Results: Johansen tests for Cointegration
Maximum Eigen value Trace 5% critical
rank statistics value

0 . 149.6556 94.15

1 0.87922 92.5840 68.52

2 0.75185 54.9530 47.21

3 0.62324 28.5969* 29.68

4 0.50312 9.7131 15.41

5 0.25692 1.6953 3.76

6 0.06086

Number of obs = 27, Lags = 2

Source: Computation results of data from appendix 1

From Table 5.5, the test reveals that there is cointegration and there is only three maximum rank
of this cointegration. This is because the first significant values where trace statistic is less than
critical value at 5 percent were found at maximum rank of three. This suggests that there is three
cointegrating equations.

That reveal that there exists a long-run (co-integration) relationship among manufacturing
output, exchange rate, money supply (broad money), foreign direct investment, interest rate and
trade openness.

5.6 Estimation results of the model

This section described the empirical results of the model estimated by ordinary least square
method have been performed through a multiple linear regression on STATA 14 the regression of
the dependent variables against independent variables. Furthermore, significance of the
parameter estimates, economic interpretation of the parameter estimates was found in this
section.Which included the results of R2 Adjusted R2, F test and the results on table the
interpretation was given after the displayed on the Table 5.6

34
Table 5.6 Empirical model results

Number of observations 29
P>F 0.0003
R-squared 0.6131
Adjusted R-squared 0.5290
logVA Coef. Std. Err. t p>|t|
logRER -3.64
-1.601782 .4395313 0.001
logMS 1.009815 .2169476 4.65 0.000
logIR -1.124357 .6204634 -1.81 0.083
Logfdi -.0250848 .0400021 -0.63 0.537
logTOP -.9431295 .6207344 -1.52 0.142
_cons 20.87042 .8513678 24.51 0.000
Source; Authors own calculation using data from appendix 1.

The results from Table 5.5 showed that the Prob. > F = 0.0003 indicated that the overall fit of the
regression was very good and it was significant at 1% level. The R-square was 0.6131 implied
that 61% of manufacturing output was explained by independent variables included in the
model. It is found that the adjusted r –squared which 0.5290 indicates that the explanatory
variable accounts for 52% of variation in dependent variables.

Also showed that exchange rate is significant at 5% and has negative sign. This indicated that
exchange rate has negative relationship with manufacturing output. This imply increase in
relative exchange rate lower output.

Money supply (broad money) have positive coefficient and significant at 5%. This means that
the variable had positive influence on manufacturing output, which means the higher the money
supply the higher the manufacturing output

FDI, interest rate and trade openness all are insignificant at 5% and with negative coefficient,
this implies these variables have no influence to manufacturing output.

5.7 Diagnostic test

In this section, in order to get a valid result, we used several diagnostic checking tests which are
Breush- Godfrey Serial Correlation LM test (test for Autocorrelation problem), Breush- Pagan
Godfrey test (test for Heteroskedasticity problem).

35
5.7.1 Autocorrelation
Autocorrelation often appears when working for time series data .The Durbin Watson Test is
used to test for autocorrelation from model used in the study and the results shows that there is
no autocorrelation as shown below.

Durbin Watson d- statistic (5,30) = 1.915902

5.7: Heteroscedasticity
The multiple linear regression assumption required for ordinary least square estimator to be
efficient when the variance of the error term has to be constant and the same for all observation
is homoscedasticity .When assumption is violated and the variance is different for different
observation it is referred to as heteroscedasticity and testing for heteroscedasticity was done by
using STATA14.The Breusch-Pagan Test was used for heteroscedasticity test, under the
assumption of the Breusch-Pagan test asymptotically follows the chi-distribution with first
difference. The results shows, there is no heteroscedasticity.

Breusch-Pagan / Cook-Weisberg test for heteroskedasticity

Ho: Constant variance

Variables: fitted values of logVA

chi2 (1) = 0.64

Prob > chi2 = 0.4229

4.8 Summary
Chapter 5 basically analyzed the empirical results throughout Unit Root test, Cointegration test
and diagnostic checking test. All the empirical results have been shown clearly in the tables with
precise explanation. The discussion of the whole research will be carried out in Chapter 6.

36
 CHAPTER SIX
CONCLUSION, POLICY IMPLICATIONS AND RECOMANDATIONS

6.1 Overview
The first part of this chapter will present the discussion on the major findings of this paper is
provided in order to validate the hypotheses and the research objective. Next, the implication,
limitations, recommendation for future research and conclusion of the entire study will be
discussed.

6.2 Decisions for Hypotheses of Study

Table 5.7 Decisions for Hypotheses of Study

Hypothesis Decision

1 Exchange rate has positive relationship with Not support

manufacturing output

2 Exchange rate has negative relationship with support

manufacturing

6.3 Main Findings

This study was conducted with the main objective is to examine the effects of exchange rate on
manufacturing output in Tanzania. The study was conducted via trend analysis and explored
the nature and pattern of the study variables. Secondary data obtained from various statistical
abstracts for the period 1988-2017 was used in this particular study. Ordinary Least Square
(OLS) was employed as an estimation technique in modeling the relationship among the key
and other moderating variables upon conducting various tests. The study variables used were
manufacturing output and exchange rate as a variable of interest while FDI, interest rates,
money supply and trade openness as other control variables. The hypothesis in this study was
that exchange rate had a significant effect on manufacturing output in Tanzania. The study
hypotheses were tested at 1%, 5% and 10% significance levels.

37
The diagnostic tests carried out for all variables were all satisfied, that is, no serial correlation
and heteroskedasticity were observed, implying that the estimates are reliable and therefore can
be relied upon. The methodology employed in this study included the regression analysis to
examine the impact; stationary test was carried out using the Augmented Dickey-Fuller
technique. The results of unit root suggested that both variables in the model were stationary
after first difference.

Discussion on Major Findings

This study found that exchange rate do affect manufacturing output in Tanzania. Whereby
there is significant relationship between exchange rate and manufacturing output. Furthermore
exchange rate has negative relationship to manufacturing output. This is in line with the
existing literature in chapter two that exchange rate fluctuations will cause instability in
purchasing power and impact the importation of manufacturing inputs in turn lower
manufacturing output.
Also broad money supply was found to be significant and positive related in the model. This
implies that fluctuations in the broad money supply do affect manufacturing value added. This is
consistent with the existing literature that either says that broad money supply will either affect
manufacturing sector growth positively or negatively.But FDI, interest rate and trade openness
all are insignificant at 5% and with negative coefficient, this implies these variables have no
influence to manufacturing output.

6.4 Policy implications and recommendations

The policy implications of this study can be summarized in the following points. First, there
exists a relationship between exchange rate, broad money and manufacturing output performance
of Tanzania. This relationship indicates that the Government of Tanzania should utilize the
above factors carefully on a long-run perspective to capitalize the benefits of the nexus properly.

Second, since exchange rate and money supply are important factors in explaining the changes in
manufacturing sector performance. Thus, exchange rate and money supply-led growth policy can
be advocated to increase the country’s overall manufacturing sector performance. Third, since it
has been revealed that any high exchange rate has a significant negative impact on
manufacturing sector performance, measures for its stabilization are important to be considered.

38
Strategies such as improving economic productivity by improving infrastructure and provision of
labour force training should be encouraged as well. Promotion of small and medium
manufacturing firms, on the other hand, should be given priority as they constitute most part of
Tanzanian manufacturing sector and as they contribute to an increase of GDP. Strategies like
loan provision schemes with affordable interest rates and establishment of permanent markets for
their products

should be undertaken. Moreover, policies and plans to formalize informal sector in Tanzania
should be continuously designed as the sector constitute the large part of the economy.

6.5 Limitation of the study

The major problem encountered in the study is access to quality and consistent data. Also
availability of data is the problem. The data used was time series data which requires data from
30 years and above. For some variables it was difficult to get data for some years especially data
from many years ago.

6.6 Further Areas of Study

One of the recommendations provided to future researchers is to extend research on the effect of
macroeconomic variables on the growth of manufacturing sector by examining other
macroeconomic variables such as inflation rate, domestic credit available, and size of the
workforce in the research.

In addition, future researchers can use larger sample size of data in order to gain a much better
understanding of the dynamics between macroeconomic variables and manufacturing sector
growth. Frequency of data can be increased by using weekly or monthly frequencies to raise the
sample size and to get a more in depth look at the factors affecting manufacturing sector growth.

39
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