Export Promotion through Exchange Rate Changes: Exchange Rate Depreciation or Stabilization?

Abstract

Exchange rate movements affect exports in two ways?rate depreciation and rate variability (risk). A depreciation raises exports, but the associated exchange rate risk could offset that positive effect. The present paper investigates the net effect for eight Asian countries using a dynamic conditional correlation bivariate GARCH-M model that simultaneously estimates time-varying correlation and exchange rate risk. Depreciation encourages exports, as expected, for most countries, but its contribution to export growth is weak. Exchange rate risk contributes to export growth in Malaysia and the Philippines, leading to positive net effects. Exchange rate risk generates a negative effect for six of the countries, resulting in a negative net effect in Indonesia, Japan, Singapore, and Taiwan and a zero net effect in Korea and Thailand. Exchange rate movements affect exports in two ways?rate depreciation and rate volatility (risk). The two effects have received considerable attention since the collapse of fixed exchange rates in the early 1970s. But, no research considers the net (total) effect on exports of the two potentially offsetting effects. This paper investigates the net effect for eight Asian countries with Engle's (2002) dynamic conditional correlation (DCC) bivariate GARCH-M model that simultaneously estimates time-varying correlation and exchange rate risk. The net effect relates to the goal of a foreign exchange intervention. Depreciation lowers the foreign currency price of exports and probably increases the quantity of exports and export revenue in domestic currency. Conditions may exist, however, where export revenue falls. Highly inelastic foreign import demand leads to falling export revenue. Ambiguity also arises if export production incorporates high import content, since the domestic cost or price of exports rises with depreciation. During periods of appreciation, exporters might price to market, lowering their domestic currency price to maintain export market share. Theory and empirical evidence exhibits ambiguity as to the effect of the exchange rate on exports and export revenue. Junz and Rhomberg (1973) and Wilson and Takacs (1979) find that devaluation