The Impact of Exchange Rate Volatility on Trade Balance of Iran

Abstract

The real effective exchange rate is one of the essential indicators of economy’s international competitiveness, and therefore, has a strong impact on a country’s foreign trade development. It is commonly believed that the movements of the real effective exchange rate have a permanent effect on exports and imports. This study addresses the question of whether exchange rate volatility has any significant and direct impact on trade balance. Hence, the purpose of this study is to estimate the effect of real effective exchange rate volatility on the balance of trade of Iran during the year 1993 to 2011. By using Unit Root Tests, GARCH (1, 1) approach and balance PANEL data model. Results demonstrate that the real effective exchange rate has no significant effect on the trade balance. So, it is important to stress that real effective exchange rate volatility cannot be used solely in managing the trade balance of Iran with main trading partners. We find that trade balance is affected by import, rather than export. Thus, in order to boost the trade balance the government should implement the policy that focuses on the production of imported substituting goods.