Nonlinearity in exchange rate pass-through across BRICS: Role of business cycle and inflation

The present study examines the sensitivity of exchange rate pass-through (ERPT) to the business cycle and rate of inflation in the case of five emerging market economies, namely BRICS (Brazil, Russia, India, China, and South Africa). Existing literature on the ERPT has documented inconclusive evidence, focusing more on developed economies. However, emerging markets like BRICS are given only peripheral attention, especially in the nonlinear framework. Using a backward-looking Philips curve analytical framework and the logistic smooth transition regression (LSTR) method, we found (1) ERPT coefficients are greater than zero but less than one, implying that exporters neither follow producer or local currency pricing. (2) With inflation as a transition variable, the Taylor hypothesis is validated in the case of three (Russia, India, and South Africa) countries wherein the degree of ERPT increases with the inflation rate, unlike in the case of Brazil and China. (3) With output growth as a transition variable, the ERPT is found to be more during a boom than during a recession for Russia and South Africa. In contrast, in the case of India, ERPT responds negatively to the level of economic activity. In the case of Brazil and China, however, no evidence of nonlinearity was established with respect to output growth. (4) Our results advocate adopting effective and credible policies like inflation targeting regimes and stable output growth to avoid appreciable pass-through of exchange rate changes into domestic inflation. Such policies enhance the credibility gains and may thus lead to low ERPT.