Exchange Rate Volatility and Iran's Bilateral Imports from Turkey

To explain the impact of exchange rate volatility on international trade flows many empirical studies have investigated. Most empirical findings, which are primarily concerned with exports, confirm that an increase in exchange rate volatility tends to generate uncertainty which may have a negative impact on trade flows. The current study tends to estimate the impact of exchange rate volatility on demand for bilateral imports for Iran, using bilateral import data from selected external source of Iran. Although the effectiveness of import policy depends on the magnitude of each country’s import elasticity with respect to income, price, exchange rate and volatility of exchange rate, the current policies might not be more effective unless they meet import elasticity of particular trading partner countries. Hence, the main objective of this study is to offer that different policies should be implemented for trading partners instead of a single trade policy to improve trade balance. For policy perspective, it is important because trade policies based on aggregate import elasticity might be deceptive, if bilateral import elasticity is different from those of aggregate import demand model. (Alam and Ahmad, 2011) There have been numerous studies carried out across the globe focusing on the relationship between exchange rate volatility and bilateral import. To the best of our knowledge, there is not any study investigating the relationship between exchange rate volatility and bilateral import for Iranian economy. The objective of the present study is to investigate the effect of exchange rate volatility on Iran’s bilateral import from her selected trading partner country, Turkey, during 2003Q1 to 2012Q4. The selection of the country is justified by the fact that Iran’s imports from this neighbor country is increasing and Turkey is one of Iran's major trading partner countries. On the other hand, these two countries are planning to come up 30 billion dollars in their bilateral trade up to 2015. The reason for sample period started from 2003Q1 is approval of equalization in exchange rate. The present empirical study differs from previous research for Iran in various dimensions. We employ ARDL approach to detect short-run and long-run impact of exchange rate volatility on aggregate demand for imports. The paper uses real effective exchange rate to construct the measure of exchange rate volatility. We also apply GARCH process for estimating volatility of real effective exchange rate. Our results show that income elasticity is significant and exchange rate volatility is negative and statistically significant for Iran’s bilateral import from Turkey in long run.Our data set covers the period from 2003Q1 to 2012Q4. The Data series of bilateral imports were taken for selected importing country of Iran namely Turkey which were collected from the IMF's Direction of Trade Statistics (DOTS). Gross domestic product, consumer price index, unit value index of import and real effective exchange rate for Iran were compiled from the IMF's International Financial Statistics (IFS). All real values are measured on base of year 2005 and all of the series are transformed into natural log form. Log transformation can trim down the problem of heteroskedasticity (Gujarati, 2003). The impact of volatility in the exchange rate on Iran's bilateral imports from selected source is estimated by using the ARDL approach. This paper does not include all dimensions of dynamic relationships between Iran's bilateral imports and real effective exchange rate volatility but limited to the following variables: Dependent variable • Real bilateral imports is a ratio calculated by dividing the bilateral import over unit value index of import. Independent variables • Real gross domestic product is the ratio of nominal gross domestic product to consumer price index. Expected sign for this variable is positive, because an increase in real income, increases domestic demand for import. • Relative price of imports is a ratio calculated by dividing the unit value index of import over consumer price index. It is expected to find a negative relationship between real bilateral imports and relative price of imports. • Real effective exchange rate measures the changes in the competitiveness of a country by taking into account the changes in the relative prices between the countries involved. (Pelinescu and Caraiani, 2006). This index is expected to have a positive relationship with real bilateral imports. • Real effective exchange rate volatility is a measure that intends to capture the risk faced by traders due to unpredictable fluctuations in the exchange rate. The study used GARCH models for this variable. The effect of this variable on the import demand depends on whether the trader is risk-neutral or risk-adverse.The dynamic relationship between bilateral import demand for Iran and exchange rate volatility as well as some important explanatory variables with Turkey has been examined by applying the ARDL approach, suggesting a long-run relationship among selected explanatory variables over the sample period for Iran’s bilateral imports from Turkey. The income elasticity of imports is positive and significant which indicates that as real income growth occurs in Iran, it demands more imports from Turkey. The result also shows that relative price elasticity for bilateral imports significantly and negatively affects bilateral imports from Turkey, suggesting that import of goods decrease by increasing import price. The present study also confirms that devaluation has significant contraction effect on Iran’s bilateral imports. The result further suggests that exchange rate volatility reduces the demand for Iran’s bilateral import from selected partner in the long run. This study concludes that short run disequilibrium converges very soon in the long-run. Finally, for policy makers, the present study suggests that a single trade policy is not too effective. Policy makers should make separate policies for neighbor trading partners, according to their trade relations with Iran and in the light of present analysis.