The Effect of Gross Domestic Product on Balance of Payment: (The Case of Ethiopia

Abstract

This study analyzed the effect of gross domestic product on balance of payment (BOP) on Ethiopia. The study employed the Autoregressive Distributed Lag Model (ARDL) and Bounds test for the co-integration approach using time series annual data for the period 1998 – 2021. The macroeconomic variables used in this study include real gross domestic product, real exports, real import, foreign direct investment and inflation rate as an explanatory variable and balance of payment as dependent variable. The co-integration results confirm the presence of a long run relationship among variables in all models. In order to capture the short run effects of the balance of payments deficit, the study employed the Vector error correction model (VECM) and decided based on a five percent level of significance. Focusing on the core explanatory variable, which is on balance of payment, the empirical results discovered a negative and significant relationship between on balance of payment and gross domestic product in both the short run and long run period, implying that the effect of macroeconomic variables deteriorates balance of payments deficit. Moreover, the results show a direct but significant relationship between on balance of payment and gross domestic product in short run and long run period in Ethiopia. Consequently, in order to contain this adverse effect, the government should ensure that the exacerbated level of balance of payments deficit where addressed. The findings approve that effective policies that promote exports and boost trade have a positive impact on economic growth in Ethiopia. Therefore, promoting expansion of the export sector and maintaining a favorable balance of payments position in various ways can enhance economic growth and a surplus balance of payments in Ethiopia.