Memoire Online - Welfare implication of determinants affecting aggregate consumption expenditures in Rwanda

James Duesenberry (1946) in his relative income hypothesis rejected the fundamental assumption of consumption theory of Keynes. He challenged the assumption of the independence of individual's consumption and postulated interdependence in consumption behavior. He posited that consumption behavior is not independent but interdependent on the behavior of every other individual. He explained that people do not only derive satisfaction from consumption but also from how the consumption compares with that of others. (Ahuja: 2013).

As such, the relative size of a household income to that of other households determines consumption level. The hypothesis is based on three relative aspects:

? A household's income position is relative to its associates or group to which it belongs.

? The wellbeing of society depends on Government intervention through economic measures.

By this, he posited that households strive constantly toward a higher consumption level and emulate the consumption pattern of a neighbor. (Ohale: 2002).If income of all individuals/household increases by the same percentage, and then relative income would remain the same despite the increase in absolute income. Since the relative income remains the same, the same proportion of income would still be spent on consumption, Average Propensity to Consume (APC) will thus, remain the same. To capture the determinant of aggregate consumption expenditure in Rwanda, the following model has been specified by the researcher: GCE= f(Y, INT, INF, and EXR).Where GCE = Gross Consumption Expenditure Y= Income (GDP), INT= Interest Rate, INF= Inflation Rate, EXR= Foreign Exchange Rate.

? Gross Consumption Expenditure proxied by GCE is the consumption without tax or other contributions having been deducted. In other words, it is the consumption at current prices used by household in the community.

? Income: The researcher used GDP as a proxy for income. A positive sign is expected as there is a direct relationship between consumption and income. Consumption expenditure is expected to increase with an increase in income.

? Interest Rate: (Proxied by INT) an increase in lending interest rate may lead to a decrease or increase in consumption. As such, the expected sign was determined by researcher findings.

? Inflation Rate: we use INF as a prosy of inflation rate. This tries to capture the effect of increase in price level of consumption. When there is inflation (general price level increase), the real value of the consumer's cash balance is falls. As such their purchasing power is hampered, leading to a fall in consumption expenditure. Thus an inverse relationship is expected to occur between inflation and consumption; therefore, the researcher interpreted this hypothesis regression.

? Exchange Rate: The researcher used EXCHR as a proxy of exchange rate. The researcher attempted to capture how households react to changes in price of foreign goods by including exchange rate of Rwandan currency to dollar in the used model. This stems from the fact that about 1837.3 b Frw of consumer goods is imported from foreign countries which include food items, services, automobiles, etc. While Exported goods are 846.15 b Frw. Thus the expected sign of the relationship between exchange rate and consumption expenditure shown by the researcher after regression. To estimate the results, the researcher employed the ordinary least square (OLS) method of estimation to check for variables that determine consumption.

Year	GDP	EXCH	CPI	GCE
1995	338.21	262.18	37.5	327.73
1996	423.41	306.82	40.07	398.87
1997	557.83	301.53	44.88	527.68
1998	621.49	312.31	47.67	577.77
1999	607.77	333.94	46.52	554.34
2000	674.18	389.7	48.34	631.31
2001	739.79	442.99	49.95	637.91
2002	798.62	475.37	50.95	713.06
2003	994.65	537.65	54.74	876.37
2004	1206.87	577.45	61.45	1056.7
2005	1439.176	557.82	66.99	1149.1
2006	1715.81	551.71	72.94	1340.7
2007	2067.5	546.96	79.56	1520.6
2008	2624.88	546.85	91.85	2017.9
2009	3017.56	568.28	97.74	2318.6
2010	3323.84	583.13	100	2583.3
2011	3847.98	600.31	105.67	3001.6
2012	4435.24	614.3	112.3	3440.1
2013	4862.73	600.31	121.32	3614.7
2014	5379.87	614.3	122.87	3988.9
2015	5741	701.03	123.91	3862.7

Table 1: Status and trends of gross consumption expenditure, Gross domestic product, Interest rate, Consumer price indices (Inflation) and exchange rate in Rwanda from 1995 up to 2015

Figure 2: Status and trends of gross consumption expenditure, Gross domestic product, Interest rate, Consumer price indices and exchange rate in Rwanda from 1995 up to 2015

Gross Consumption Expenditure: According to the above figure, the post 1994 Genocide (from 1995), household consumption in Rwanda was very low where percentages show that 94.31 % of Rwandans consumed 327.73 Frw. Because of post war period, the economic system were destructed, infrastructures were ruined by the war so that every economic sector were shocked. But from 1995, statistics show that there is an increase of the level of gross consumption expenditure from 1995-2015 where it started from 327.73 Frw from 1995 and grew slowly until 2004 where consumption reached 1056.73. Within 3 years (from 2005 to 2007), the level of consumption grew quickly where it reached 1520.55 Frw. Because different initiatives put in economic sector by the Government of Rwanda, the level of consumption were increased at high rate where from 2008 to 2011, an increase of 983.67Frw whereby 78% of Rwandans consumed 3001.55Frw. From that period, the level of consumption grew slowly by 422.6 Frw because of different economic challenges.

Gross Domestic Product: According to the above figure, using the documentary technique, the researcher has obtained data from the World Bank. The data have been analyzed and interpreted using the statistical, analytical and synthetic methods. The statistical method helped the researcher to plot the evolution of GDP of Rwanda from 1995 to2015. The figure 2 above shows that the gross domestic product has the upward trends. They are increasing over time because from 1995 up to 2003, the level of GDP has grown by 656.44 b Frw, but because of economic reconstruction as well as the whole country, this level grew slowly in a period of 8years thereafter that period, the level of GDP grew rapidly because after presidential elections, many policies put in action such as increase of foreign direct investment, increase of domestic agro processing industries, financing the small and medium entrepreneurs, etc. Normally, this is shown by the above given figures where from 2004 up to 2009, there is a high increase compared to the starting period with 1810.69 b Frw which means that is are positive trend. From 2010 up to 2015, there is a continuous increase in GDP because the level of increase is 2417.16 b Frw.

Exchange rate: The exchange rate in Rwanda has been fluctuated in four main categories under relative period from 1995-2015. From 1995, the Government of Rwanda introduced the regime of floating exchange rate where this exchange rate is allowed to fluctuate in response to the economic condition. We normally know that in a fixed exchange rate regime, the Central Bank trades domestic for foreign currency at a predetermined level of price. The post Genocide period of 1995-2015 was a period of reconstruction in whole Country particularly in the economic system. Therefore, from 1995 up to 1999, the; level of exchange rate has been fluctuated (increased one hand and decreased on the other hand). The lower level of net export which is the exports minus imports is the main determinants of exchange rate. This lower level of net export was low from many years ago because Rwanda is a landlocked country and it does not have natural resources that can induce the level of domestic production as well as the level of export. With policy of monetary targeting used by the central bank of Rwanda, from 2000 up to 2005, the money market which is introduced in the period of 1999-2005 to increase the level of transactions among domestic commercial institutions. This has changed many things in Rwandan economic system. The system faced an increase in money supply where this increase in money causes a decrease of interest rate of bonds. Because we are in open economy, the domestic rate of interest would be equal to the world one. So the system faced many investors who converted Rwandan currency into foreign currency to invest outside of the Country (Capital outflows). There is therefore a depreciation of the domestic currency. This depreciation of the domestic currency causes the exchange rate to flow down, induce the level of net export without forgetting the level of income. Even if it is so, the national

export, at lower level than import, have a lower price outside the country. The introduction of capital market in Rwanda in 2005 did change nothing on depreciation of Rwanda currency. From 2005 up to 2011, the exchange rate continued to decrease where it shifted from 557.82 to 600.31 by one dollar. Because of the trade balance deficit faced by Rwanda economic system a longtime ago, there is a continuous decrease of exchange rate which depreciate our domestic currency whereby from 2012 to 2015, domestic currency depreciated by 2.81%. Without going far from the facts, an increase in Government spending (Expansionary fiscal policy) is the only solution because it can increase income and interest rate on bonds which can make capital inflows and appreciate the domestic currency. The level of exchange rate will increase which will lower net export and income. Thus offset occurs between incomes.

Inflation: The annual percentage change in a Consumer Price Index (Inflation) is used to measure inflation. The Consumer Price Index (CPI) can be used to index the real value of wages, salaries, pensions, and price regulation. It is one of the most closely watched national economic statistics. The consumer price index (CPI) is a statistical estimate of the level of prices of goods and services bought for consumption by households. It measures changes in the price level of a market basket of goods and services used by households. The CPI is calculated by collecting prices of a sample of representative items over a specific period of time. Goods and services are divided into categories, sub categories, and sub-indexes. All information is combined to produce the overall index of consumer expenditures. Such that the annual percentage change in a CPI is used to measure inflation, in Rwanda, the level of inflation measured by CPI, from 1996-2002, the levels of price were decreasing because many people were outside the country due to the 1994 Genocide while domestic production were high. With many programs of sensitizing refugees to comeback because of security, the level of population increased and the level of price started to rise due to lower level of production.

However, in 1999, a shock happened where the level of price decreased gradually and it riches a negative value. This was caused by high level of production (Supply) against lower level of demand. It is like a short run deflation. From 2003 up to 2008, a continuous rise of price occurred because of the continuous rise of the population. (DHS: 2005). But again from 2008 to 2015, because many policies put into action by the Government of Rwanda like, Girinka, Umurenge SACCOs, Agriculture policies of irrigation as well as new investments in different economic sectors like industrialization, financial institutions, and so on, all those policies increased the level of consumer goods therefore the level of price reduced by 12.9% which shows a high impact in the economy.

For example, imagine you buy five sandwiches, two magazines, and two pairs of jeans. In the first period, those goods are market basket at base period prices = 5(6.00) + 2(4.00) + 2(35.00) = 108.00. Market basket at current period prices = 5(7.00) + 2(6.00) + 2(45.00) = 137.00. The CPI represents the cost of a basket of goods and services across the country on a monthly basis. Those goods and services are broken into eight major groups: Food and beverages Housing, Apparel, Transportation, Medical care, Recreation, Education and communication and other goods and services. From the above example:

From the above figure, the rate of lending interest rate in Rwanda is at high level. Normally, Rwanda institutions seek for high return compared to the level of income as well as the rate of people that take credits in good collaboration with financial institutions to induce the level of investment in the community. From 1995 to 1999, the rate of lending interest was 17 and 16%. This is the post Genocide period where financial institutions started to reconstruct without enough capital as well as qualified employees. The monetary authorities and commercial banks have had faced the problem of dealing with the lower level of money. Measures were put in place to call upon people to use credits as a financial support in order to induce the level of investment in Rwanda as well as domestic production. Fluctuations continued where from 2003 to 2009, the level of interest rate changed from 16 to 17%. The introduction of money market and capital market (1999-2005) has had affected the increase of that rate. However a continuous depreciation of the domestic currency affects the level of interest rate because the economic system cannot attract foreign investors. From 2010 to 2015, the level of interest rate changed from 18 to 19%. Local people as small and medium entrepreneurs are not attracted by financial institutions to take loans because of that high level of interest rate. If is so, the level of investment cannot increase to affect the level of income. By lower level of income, household consumption is also decreased.

With the above findings, the explained variable GCE has upward trend as it is shown by numbers. By 1995 to 2003, the level of consumption increased from 327.73 Frw up to 876.37 Frw per household (96.95% to 88.1%) i.e 96.95 % of household in Rwanda consumed 327.73 Frw in 1995, this is the post 1994 Genocide in the country where all sectors including economic ones were destructed by conflicts. However, after presidential elections, the level of consumption in Rwanda has gradually increased again because of many policies put into action by the Government of Rwanda. From 2004 up to 2007, the levelof consumption faced a high increase because 87.55% up to 73.51% of Rwandan consumed between 1056.73 Frw to 1520.55 Frw. Thereafter, from 2008 up to 2015, the level of consumption has been increased by about 2.55% where a decrease vary between73.51% to 69.4%. Generally, from 1995 up to 2015, the level of income has affected positively the gross consumption expenditure. The continuous level of interest rate is a challenge to the household market basket. The level of inflation is also a challenge to the consumption because the income from investments is affected by inflation. A continuous depreciation of the domestic currency to the dollar causes the imported goods to be very expensive. Therefore, the next chapters give the econometric facts to know the exact relationship between variables used in the model. Therefore, the researcher affirms, based on the first hypothesis that the trends of the used model are upward sloping and the used variables are significantly related.

CHAPTER 3: ECONOMETRIC ANALYSIS OF THE RELATIONSHIP BETWEEN GROSS CONSUMPTION EXPENDITURE AND ITS DETERMINANTS IN

Welfare implication of determinants affecting aggregate consumption expenditures in Rwanda

2.1. Evolution of gross consumption expenditure in Rwanda 1995-2015