Imports under a Foreign Exchange Constraint

Abstract

To assess proposed macroeconomic adjustment programs, policymakers must estimate import demand relative to the foreign exchange available. Traditional models estimate import demand as a function of relative prices (the real exchange rate) and income (gross domestic product) but omit changes in foreign exchange. In the 1980s, however, declines in foreign lending and the terms of trade and increased debt service costs reduced foreign exchange availability in most developing countries and limited import capacity. In this article two import models are presented which incorporate both the traditional variables and indicators of import capacity—foreign exchange inflows and international reserves. The first model assumes that import prices are exogenous, but in the second model import prices are endogenous—allowing for government attempts to reduce import demand by increasing the domestic import price. The models are estimated using data for twenty-one developing countries for 1970–83. The results suggest that the import model presented here does a better job of explaining import behavior than do the traditional model (which excludes changes in foreign exchange) and the Hemphill model (which excludes relative import prices and income).