Test for purchasing power parity in selected African countries

This paper tests for the purchasing power parity condition in selected developing countries in Africa, that is; Kenya, Rwanda and Nigeria . The purchasing power parity condition is widely used as a predictor of future exchange rates of a country and to assess the viability of investment in a foreign country. Though not a robust determinant of the behavior of exchange rates, its wide spread application by policy makers, journalists, the government and international officials makes it difficult to ignore the implication it may have on a country's economy. It is therefore important to know whether the parity condition holds and its subsequent implications. This paper used a period of 63 years therefore overcoming the problem of small datasets employed by previous researchers in the field such as (Kargbo, 2004). It also employs the use of Johansen cointegration to test for this condition. It is a robust model as it takes into account the short-run dynamics of the variables, whilst permitting the system of variables to return to long-run equilibrium according to the purchasing power parity doctrine (Verbeek, 2004). The researcher finds that in the long run purchasing power parity holds in Kenya and Rwanda but not in Nigeria. To further explain this disparity in findings, the researcher tests for trade openness in the three countries to see whether this causes the lack of purchasing power parity to hold Nigeria. Lack of trade openness is seen to affect the purchasing power parity doctrine in Nigeria. This is in line with (Omar Esqueda, 2007) findings