What is it about?

Volatility in exchange rates describes movements on the prices of currencies that are beyond is the equilibrium point, causing distortions in the demand for exports as volatile exchange rates could raise or lower the price of goods and for instance could change the profits of traders. This study examines to what degree the top commodities exported by Indonesia are affected by exchange rate volatility. The study focus on the top five export destination countries, namely China, India, Japan, South Korea, and the United States.

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Why is it important?

Theoretically, exchange rate volatility is negatively associated with trade flows as volatile changes in currency rates are linked to uncertainty in prices and to higher levels of risk exposure, potentially leading to changes in demand for goods. While uncertainty in exchange rates could be reduced by employing hedging instruments, that raises the cost of goods. Besides, exchange rate volatility could be accompanied by changes in prices for goods, currency depreciation - appreciation, and changes in global demand, creating a highly uncertain environment for traders. This study looks at the role played by exchange rate volatility, currency prices, and industrial development, in the demand for exports (top goods) from Indonesia, most of them natural-resource based. The 2007-2019 period is characterized by frequent movements in the exchange rate of Indonesia versus main partners, a rapid expansion in trade with rapid income growth developing countries (India and China) where hedging tools may be less frequent with developed countries (Japan, South Korea, and the United States). Exports of the top eleven goods to the top five destinations countries account for more than 30% of total exports, likely relevant for the balance of trade of Indonesia. Besides, exports of the top goods slowed down during the financial crisis and after the year 2012. While it may be expected that exports increase with a weaker Indonesian Rupiah, exports have not recovered from the fall in global demand since year 2012, likely as the currency is tight due to demand and prices of commodities. Indonesia displays the characteristics of a “commodity economy” in which changes in commodity prices are linked to volatility in exchange rates. Nearly 50% of exports from Indonesia depend on natural resources placing special pressure on exchange rate movements as commodities are more sensitive to uncertainty. A novelty of the paper arises as symmetric and asymmetric effects are compared at an aggregate level of exports. Besides, the behavior of traders could be motivated by risk aversion or risk-taker behavior, opening an empirical gap.

Perspectives

At the aggregate level, exports are positively associated with industrial production for China, India, and Korea. Besides, a weak Rupiah, expected to support exports, is negatively related to exports to China, South Korea, and the US. Only exports to Japan are positively associated with a weaker Rupiah. The long-run estimates for overall top exports suggest that volatility in exchange rates harms exports to India, Japan, South Korea, and the US, but supports exports to China. At the commodity level, in the long run, exports of ores, chemicals, rubber, and paper are affected by volatility. Exports to India experienced the largest effects due to volatility (negative), while those to China the less. Volatility also affects some exports to South Korea (rubber and paper) and to the US (chemicals, rubber, wood, and paper) in a special way. Nevertheless, exports of Indonesia have been driven mainly by the income growth of partners (mainly Asian). Exchange Rates have also played a role in exports in explaining exports to India, Japan, and South Korea, suggesting the importance of Monetary policy in supporting a stable Rupiah.

Dr Miguel Angel Esquivias Padilla
Universitas Airlangga

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This page is a summary of: The impact of exchange rate volatility on Indonesia's top exports to the five main export markets, Heliyon, January 2020, Elsevier,
DOI: 10.1016/j.heliyon.2019.e03141.
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