European Journal of Business and Management www.iiste.org ISSN 2222-1905 (Paper) ISSN 2222-2839 (Online) Vol.13, No.17, 2021 22 Impact of Exchange Rate Devaluation in Ethiopia and Forecasting Foreign Exchange Rate Using ARIMA Model Tadele Alamneh (PhD Candidate in Economics) College of business and economics, Debre Markos University, Debre Markos, Ethiopia Malebo Mancha (PhD) College of business and economics, Arba Minch University, Arba Minch, Ethiopia Abstract The exchange rate is an important indicator of economic activity that policymakers use to formulate policies. This paper is based on fitting historical nominal exchange rate time series expressed in terms of past values of itself plus current and lagged values of error term using the Autoregressive Integrated Moving Average (ARIMA) model over the period 1971-2020, resulting in the model (2,1,1) to forecast the next 15 years. The projection's performance is assessed using data from the preceding fifty years sourced from World Bank, and the forecast indicates that domestic currency depreciation will become more prevalent in order to stimulate exports. Moreover, the ARDL model is used to examine the impact of exchange rate, import, export, and inflation rate on RGDP from 1977 to 2018. The unit root test (Augmented Dickey- Fuller test) was used to verify the integration order of the variables. The five variables are used in the cointegration analysis. The bounds test of cointegration was used in this work. The results showed that the F-statistics value is greater than the upper boundaries at all levels of significance, indicating that individual variables have a long-term relationship with RGDP. This led to the estimation of the Error Correction Model (ECM), in which 25.1 percent of the disequilibrium is adjusted annually to bring the system back into equilibrium. Furthermore, nominal exchange rate and import has positive contribution to RGDP while inflation has adverse effect on RGDP in the long-run. Besides, inflation has a negative impact to RGDP in the short run due to its lag period effects. Keywords: forecasting, ARIMA model, ARDL model DOI: 10.7176/EJBM/13-17-02 Publication date:September 30 th 2021 1. INTRODUCTION 1.1. Background Every nation has three economic goals to attain both in the short and in the long run, these are achieving economic growth, creating more employment and having no or minimum inflation simultaneously. In order to achieve these goals and make their countries better off, countries use monetary and fiscal policies as a strategy and let their nation’s aggregate demand curve to shift either to the right- or left- side. The most common economic policy instruments used by governments to monitor and change their economies are fiscal and monitory measures. Fiscal policy is all about letting the government to collect taxes and spend it on public sectors like infrastructures, education and so on and which mainly focuses only on the domestic economy whereas, monetary policy deals with both domestic and international economy. Meaning, the government can use monetary policy and the exchange rate policy of devaluation in order to affect the domestic and international markets respectively (Fratzscher et al, 2014). Despite the fact that both policies appear to effect seemingly unrelated markets, it has been proved that combining them considerably helps in determining the level of production. The trade balance, net international capital movement, and other macroeconomic events are all influenced by a country's exchange rate policy. With daily trade volumes in the hundreds of millions of dollars, the foreign exchange market is the most liquid financial market (Eun and Resnick, 2018). Many developing countries' currencies are widely agreed to be "over-valued". Even when the indicators of over-valuation are clear, most countries are reluctant to devalue their currencies. There are a variety of reasons cited for not devaluing, however, the majority of them allude to Three main points: 1) Devaluation will not improve the payments position of the devaluing country; 2) devaluation may work if given a chance, but it will unleash forces in the economy that will eventually undercut its benefits and those of other economic policies; and 3) even if devaluation works, it will be politically disastrous for those in charge. Despite these sources of resistance, currency weakening or devaluation of one's own currency in terms of foreign currencies, has become a major source of growth in many countries, particularly in developing ones. Many development institutions, such as the International Monetary Fund (IMF) and the World Bank (WB) encourage devaluation as a way of economic growth in addition to financial aid and loans to their member countries for domestic firm development. It will enhance firm competitiveness, increase domestic product and output production;