Effect of oil price on exchange rate volatility in South Sudan

Abstract

South Sudan’s economy predominantly relies on crude oil exports, making it highly vulnerable to fluctuations in international oil prices. This reliance on oil revenue poses significant challenges to economic stability, particularly in managing exchange rate volatility. This study investigates the impact of oil price fluctuations on exchange rate volatility in South Sudan, a country with limited economic diversification. The primary objective is to understand how changes in global oil prices influence exchange rate fluctuations, thereby informing policy decisions to mitigate financial instability. Using monthly time series data from January 2016 to December 2023, the study employs the Exponential Generalized Autoregressive Conditional Heteroskedasticity (EGARCH) model to analyse the relationship between oil prices and exchange rate volatility. The Purchasing Power Parity (PPP) theory serves as the theoretical framework for this analysis. The results indicate that oil price fluctuations positively and significantly affect exchange rate volatility, with a coefficient of 0.033. Additionally, a significant leverage effect of 0.559 is observed, suggesting that positive oil price shocks lead to greater volatility in the exchange rate than negative shocks. Furthermore, the study finds a negative relationship between interest rates and exchange rate volatility, with a coefficient of - 0.056, indicating that higher interest rates tend to reduce exchange rate fluctuations. Based on these findings, the study recommends that South Sudan diversify its economy by investing in non-oil sectors such as agriculture, manufacturing, and services to reduce vulnerability to oil price shocks and enhance economic stability