Abstract
The aim of the paper is to find out whether euro is a convenient substitution for U.S. dollar as an anchor currency for Iranian rial and whether this replacement would affect Iran’s international trade positively. We explore these effects via Optimum Currency Area (OCA) theories using generalized least square from 2000 to 2018. Based on OCA index, euro would be a good substitution for U.S. dollar as an anchor for Iranian rial. In addition, gravity model and Generalized Method of Moments estimation confirm that substitution of U.S. dollar by euro would improve bilateral trade between Iran and its major trade partners especially the European Economic and Monetary Union (EMU). Furthermore, we confirm that a basket containing main currencies (euro, U.S. dollar, yuan, Russian rubble) would be more efficient than a single currency anchor however euro should be prominent in the basket. Such a change of anchor could positively contribute to reduction of transaction costs, diversification of external risk, rise of mutual trade exchanges between Iran and the EMU or the EU and consequent economic growth of trade partners. The paper contributes to the existing literature by comprehensive methodological approach how to identify an appropriate anchor currency.
Highlights
Major parts of Iran’s foreign exchange earnings come from exports of oil and gas, oil products and petrochemicals, which are priced and traded in U.S dollars in international markets
By following Bayoumi and Eichengreen (1997) we investigate whether the conditions are fulfilled for Iran and whether the exchange rate variability is explicable by traditional Optimum Currency Areas (OCA) criteria
As OCA index is lower than one in all cases especially for unofficial exchange rate, it is concluded that euro, yuan and rubble are preferred to U.S dollar
Summary
Major parts of Iran’s foreign exchange earnings come from exports of oil and gas, oil products and petrochemicals, which are priced and traded in U.S dollars in international markets. As a candidate, can implement Iran’s anchor currency which is typically determined by structural factors such as the direction of trade flows (Sriyana & Afandi, 2020) This new policy would stabilize the economy and would decrease effects of exchange rate volatilities. The main objective of this study is to consider the possibility of switching from U.S dollar to euro as an anchor and its effects on Iran’s trade, given the fact that there exists a gap in the related literature. To investigate this possibility the theory of Optimum Currency Areas (OCA) introduced by Mundell (1961) was applied.
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