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Advances in Social Sciences Research Journal – Vol.7, No.10
Publication Date: October 25, 2020
DOI:10.14738/assrj.710.7961.
Deekor, L. N. (2020). Exchange Rate Pass-through (ERPT) in Oil Producing Economy: Evidence from Nigeria. Advances in Social Sciences
Research Journal, 7(10) 12-26.
Exchange Rate Pass-through (ERPT) in Oil Producing Economy:
Evidence from Nigeria
Deekor, Leelee N.
Department of Economics
Ignatius Ajuru University of Education, Port Harcourt
ABSTRACT
This paper examines the pass-through of exchange rate to domestic
prices in the context of oil producing economy. Essentially, the study
utilizes an ARDL Bound cointegration test approach to determine the
short-run and long-run dynamic of the pass-through. More so, it reflects
the magnitude and the direction of the pass-through via Toda- Yamamoto VAR approach. The economic outcome of this study
contributes to debate on the extent of pass-through of exchange rate and
provides solution to intellectual puzzle on the impact of transmission of
exchange rate movement to domestic prices in oil dependent economies
Keywords: Exchange Rate, Pass-through, Domestic Prices, ARDL, Toda- Yamamoto VAR Approach.
INTRODUCTION
The extent to which exchange rate flow affect prices of imported goods and purchaser prices have
continued to garner attention from researchers across the globe. Conceptually, the process to which
domestic prices reflect currency fluctuation is called exchange rate pass-through (ERPT); connoting
the degree to which exchange rate is transferred to price level changes. In theory, it is posited that
the transmission effect of exchange rate shift on local prices will likely contribute to domestic
inflation. Hence, the ERPT is assumed to be incomplete if the prices of goods imported change by
less than one per cent. However, the incompleteness or perverseness of ERPT notwithstanding, it is
expected that, an appreciation of the currency reduces import prices, while the reverse leans
towards the case for depreciation. Empirically, studies on exchange rate shift transmission to local
prices can be categorized into three strands of literature to include; those focusing on interchange
rate transmission into disaggregated local prices of specific domestic industries; those focusing on
exchange rate shift into aggregate import prices; and those focusing on interchange rate pass- through into the consumer price index.
The view that the disparity in exchange rate programme is a micro phenomenon started with
Dornbusch (1987) seminar paper, which provides the basis for exploring exchange rate pass
through (ERPT) at micro level; and finds support in Campa and Goldberg (2005) who relate the
level of (ERPT) to the product composition of imports. On the contrary however, Marazzi et al.
(2005), Taylor (2000), Choudhri and Hakura (2006), Ca’Zorzi et al. (2007), Bussiere and Peltonen
(2008), among others, rather explore the domestic prices transmission effects of exchange rate
flows from macro perspective. Notwithstanding, the large volume of empirical literature
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URL: http://dx.doi.org/10.14738/assrj.710.7961 13
Deekor, L. N. (2020). Exchange Rate Pass-through (ERPT) in Oil Producing Economy: Evidence from Nigeria. Advances in Social Sciences Research Journal,
7(10) 12-26.
documenting the shift of exchange rate into domestic prices; the preponderance of the existing
studies focusing on developed economies tends to ignore the manner in which interchange rate
movement transmitted into domestic costs of oil producing economies.
In view of increasingly integration of the global economy coupled with the assertions that oil
producing economies are mostly imports dependent. The innovation in this study is therefore, to
account for the importance of oil price movement in confirming the behaviour of local prices
relative to exchange rate shift in the context of Oil Producing Export Countries (OPEC). In particular,
the study utilizes an ARDL Bound cointegration test approach to ascertain the short and long-run
dynamic of the pass-through. More so, it reflects the magnitude and the trend of the pass-through
via Toda-Yamamoto VAR approach. Following this introductory section, the other sections of the
paper are divided into four to include: (2) Literature Review; (3) Methodology; (4) Data and
Preliminary Analysis; (5) Results Discussion; and (6) Conclusion.
LITERATURE REVIEW
Building on the premise that exchange rate flow could affect import, producer and purchaser prices
via trade distortions, volatility of exchange rate, the share of imports in the consumption basket, the
composition of the imports in the domestic economy, among others. Several studies namely;
Karagoz et al. (2016), Mirdala (2014), Choudhrin and Hakuar (2013), Ghosh (2013), Jiang and Kim
(2013), Odria et al. (2012), Brun-Aguerre et al. (2012), Marazzi and Sheets (2007), Barhoumi
(2006), and Choudhrin and Hakuar (2006) have investigated the responses of local prices to
exchange rate shift focusing on the importance of these factors in finding the degree of the pass- through of exchange rate movement to local prices. For others, such as; He (2015), Saha and Zhang
(2014), Kumar (2014), Uddin et al. (2014), Zubair et al. (2013), Al-Abri and Goodwin (2009), Ghosh
and Rajan (2009), Bhattacharya (2008), and the likes. Their concern is on whether the pass-through
is complete, comprehensive or partial, as well as on the responses of the domestic prices to the
direction and size of the interchange rate transmission.
Starting with Brun-Aguerre et al. (2012) for example, they adopt the panel estimation techniques
to reveal that inflation, exchange rate volatility, openness and relative wealth are significant for
explaining the disparity in interchange rate pass-through of emerging markets. For Barhoumi
(2006), the differences in exchange rate pass-through into domestic prices of developing countries
is linked to three macroeconomic variables to include exchange rate regimes, trade barriers and
inflation regimes. Marazzi and Sheets (2007) attribute the declining rate of the exchange rate shift
to US prices of import to global factors such as; increasing prominence of competition from China,
a shift in import pricing pattern which follow up from the Asian financial crisis, and lastly owing to
the reduced share of material-intensive goods in U.S. imports.
Karagoz et al. (2016), Choudhrin and Hakuar (2013), and Odria et al. (2012) are different in their
methodological approaches and the data-set they employ. Their respective studies focusing on the
reaction of local prices to exchange rate pass-through in an inflationary targeting environment;
unanimously suggests that using inflation policy target could lower the impact of interchange rate
pass-through on domestic prices. Peon and Brindis (2014), Lin and Wu (2012), Gagnon and Ihrig
(2004), Taylor (2002), Mishkin and Schmidt-Hebbel (2002), among others, have also evaluated the
impact of interchange rate pass-through to local prices within the framework of inflationary
targeting environment. Taking a new look at the exchange rate pass-through in G-7 countries,
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Advances in Social Sciences Research Journal (ASSRJ) Vol.7, Issue 9, September-2020
Jiménez-Rodrígueza and Morales-Zumaquero (2016) report evidence of robust and positive
significant correlation among ERPT and inflation volatility, and that ERPT depends on exchange rate
rules.
While exploring the degree of exchange rate movement for the developed nations like the USA, UK
and Japan adopting a post-Bretton Woods industry level dataset, Bhattacharya (2008) finds a
considerable variation in the degree of pass-through across industries and countries. For the
Nigeria data set, Zubair et al. (2013) uses structural autoregressive model to investigate the shift of
exchange rate movement to local prices in Nigeria, and the findings from impulse response suggest
that the exchange rate shift is incomplete. The Saha and Zhang (2014) comparative study, which
explores exchange rate pass through for import costs and local prices in Australia, China, and India
also suggests that the pass-through is relatively lower in China and India.
On the contrary however, Al-Abri and Goodwin (2009) use non-linear estimation technique to re- examine exchange rate shift into import prices of 16 OECD countries, finding shows that import
prices react faster and by a greater extent to exchange rate shock. In a similar development, Aleem
and Lahiani (2014) model exchange rate shift in Mexico using a threshold VAR, and their results
show that exchange rate shift into local prices is statistically significant above onset level of the
inflation rate, but insignificant.
Ahmad and Muda (2013), estimate exchange rate pass-through for Sukuk issuing countries and
using recursive VAR model, and their finding shows that import and purchaser prices pass-through
increase in the long period in Bahrain and Saudi Arabia, but the magnitude is low for other
countries. In their analysis of the European EU member states, Beirne and Bijsterbosch (2011) study
reveals that the ERPT is greater for countries that have adopted a fixed exchange rate regime.
Yanamandra (2015), Jimborean (2013), also find a statistical significant of exchange rate pass- through in their respective investigation of the responses of local prices to exchange rate shift.
METHODOLOGICAL FRAMEWORK
The Model
To examine the short and long run dynamic of exchange rate flow and the trend and extent of the
shift into the home prices in Nigeria. This study built on the decree of one price, which is the same
theoretical foundation used by previous authors such as Al-Abri and Goodwin (2009); Campa and
Goldberg (2002), among others. The decree of one price for example, posits that changes in
interchange rate are expected to be fully reflected on home prices such that; 1% change in rate of
exchange leads to 1% change in home prices (complete pass-through). Consequently, the law refers
to less than one-to-one response of local prices to the exchange rate as incomplete pass-through.
Following Campa and Goldberg (2005) as cited in Barhoumi (2005), the exchange rate flow model
represented as the elasticity of import costs to a change in exchange rates could be stated as thus;
where is the local currency price of the commodity in the local country, is the foreign currency
price of the product in the foreign country and e is the rate of exchange of the local currency for each
unit of the foreign currency. Equation (1) can be expressed in terms of import costs as:
( ) * dp ep t t = 1
t p *
t p
mp
t p