Exchange-Rate Volatility, Exchange-Rate Regime, and Trade in OIC Countries

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  • This article was downloaded by: [University of Newcastle (Australia)]On: 17 March 2014, At: 09:13Publisher: RoutledgeInforma Ltd Registered in England and Wales Registered Number: 1072954 Registeredoffice: Mortimer House, 37-41 Mortimer Street, London W1T 3JH, UK

    Journal of Asia-Pacific BusinessPublication details, including instructions for authors andsubscription information:http://www.tandfonline.com/loi/wapb20

    Exchange-Rate Volatility, Exchange-RateRegime, and Trade in OIC CountriesWai-Ching Poon a & Chee-Wooi Hooy ba Monash University Sunway Campus , Selangor , Malaysiab University Science Malaysia , Penang , MalaysiaPublished online: 05 Aug 2013.

    To cite this article: Wai-Ching Poon & Chee-Wooi Hooy (2013) Exchange-Rate Volatility, Exchange-Rate Regime, and Trade in OIC Countries, Journal of Asia-Pacific Business, 14:3, 182-201, DOI:10.1080/10599231.2013.772843

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  • Journal of Asia-Pacific Business, 14:182201, 2013Copyright Taylor & Francis Group, LLCISSN: 1059-9231 print/1528-6940 onlineDOI: 10.1080/10599231.2013.772843

    ARTICLES

    Exchange-Rate Volatility, Exchange-RateRegime, and Trade in OIC Countries

    WAI-CHING POONMonash University Sunway Campus, Selangor, Malaysia

    CHEE-WOOI HOOYUniversity Science Malaysia, Penang, Malaysia

    The authors examine the impact of exchange rate volatility ontrade in the Organization of the Islamic Conference (OIC) coun-tries from 1995 to 2008 using panel estimations to distinguishdifferences between disaggregate trade, and examine its thresholdeffects. Results reveal that exchange rate volatility generally has sig-nificant negative effect on export and import with lag. However,exports of OIC with flexible exchange rate regime have signifi-cant positive exposure to exchange rate volatility. The authors alsodocument a threshold effect for countries with trade value consti-tutes more than 30% of the real gross domestic product, and theexchange rate volatility becomes significant positive for export butsignificant negative for import with lag.

    KEYWORDS exchange rate volatility, exchange rate regime,trade, OIC

    INTRODUCTION

    Although there have been many studies on trade flows in developed anddeveloping countries, there is little examination of exchange rate volatility toexport and import for members of the Organization of the Islamic Conference

    Address correspondence to Wai-Ching Poon, School of Business, Monash UniversitySunway Campus, Jalan Lagoon Selatan, 46150, Bandar Sunway, Selangor, Malaysia. E-mail:Poon.wai.ching@monash.edu

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  • Exchange Rate Volatility and Regimes on Trade in OICs 183

    (OIC). Previous studies employed aggregate data on a single OIC countryor a selective of small numbers of OIC countries, but results were mixed.This article aims to fill the gap by examining a more comprehensive studyon the OIC countries collectively to investigate the impact of exchangerate volatility on disaggregate trade flows for 30 OIC nations using panelregression analysis.

    Since the breakdown of the Bretton Woods system and the appearanceof floating exchange rates in 1973, there has been substantial literature onthe effects of exchange rate uncertainty on trade volumes, trade flows, andtrade balance. Economic theory is ambiguous on the impacts of increasingexchange rate volatility on trade. There is no consensus on how exchangerate volatility influences international trade. Some economists argue thatexchange rate volatility increases uncertainty and thus discourages trade.In an uncertain trade environment, simple trade-offs between the exchangerate system and trade volume might not be assured. Since the mid-1980s,there has been an inclination toward more flexible exchange rate regimes,and there are conventional beliefs that a pegging system has lower regimedurability and it is more difficult to sustain pegged rates because of thewidespread liberalization and expansion of capital movements, as comparedto developed economies with flexible exchange rate systems. Hence, thereis no simple answer to the question of what exchange rate regime to choose.From Table 1, it is noteworthy that many developing OIC countries peg theirexchange rates to a single currency or to a currency basket; in particular sixare emerging markets (Egypt, Indonesia, Malaysia, Morocco, Pakistan, andTurkey) and one is an advanced country (Kuwait).

    Intuitively, emerging markets are more exposed to capital flows thandeveloping economies, and countries with flexible exchange rates are morevolatile than countries with pegged exchange rates (Figure 1). Countries thatuse the pegging system depicted varied exchange rate volatility, rangingfrom 0% to 3.5%, 0% to 16%, and 0% to 4.5% for pegging to the euro, U.S.dollar, and basket of currencies, respectively. Comparatively, exchange ratevolatility for flexible regime countries could be as high as 170%. This couldbe due to a number of factors, including the costs of institutions required tomanage an independent monetary policy and efficient growth of the domes-tic financial market. Pegging to a single currency helps to minimize potentiallarge transaction costs and exchange rate risks, and hence there is low like-lihood of rampant speculation. In terms of trade patterns, it is noteworthythat economies with floating exchange rates typically have higher levels ofinternational trade than economies with pegged exchange rates; in particu-lar, economies with managed float exchange rates typically have somewhathigher trade levels than independent float economies (Figure 2).

    Members of the OIC countries are a heterogeneous mix of Islamiccountries that spread across 10 regions and observer groups at variousstages of economic development with different levels of income. Most OIC

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  • 184 W.-C. Poon and C.-W. Hooy

    TABLE 1 Selected Organization of the Islamic Conference (OIC) Members and TradeContributions to Real Gross Domestic Product (GDP) (2005)

    Trade as a Percentage ofReal GDP (%)

    Member State

    YearJoinedOIC 1980s 1990s 2000s

    Albania, Republic of (independent float) 1969 0.76 1.19 2.82Algeria, Peoples Democratic Republic of (managedfloat)

    1969 3.28 3.00 6.46

    Azerbaijan, Republic of (pegged to U.S. dollar-eurocurrency basket)

    1969 0.00 2.03 8.88

    Bangladesh, Peoples Republic of (pegged to U.S.dollar)

    1969 1.76 2.81 4.31

    Benin, Republic of (pegged to euro) 1969 2.13 2.49 6.60Brunei Darussalam, Sultanate of (currency boardarrangement)

    1969 5.22 7.56 8.75

    Burkina Faso (pegged to euro) 1969 1.86 2.04 2.60Cameroon, Republic of (pegged to euro) 1969 2.08 2.49 3.74Chad, Republic of (pegged to euro) 1969 0.91 0.88 3.97Comoros, Union of the (pegged to euro) 1969 2.47 3.40 4.46Cte dIvoire, Republic of (pegged to euro) 1969 3.82 4.25 7.24Egypt, Arab Republic of (independent float) 1969 2.81 2.52 5.06Gabon, Republic of (pegged to euro) 1969 4.60 5.65 8.24Guyana, Republic of (pegged to U.S. dollar) 1969 9.45 16.38 19.28Indonesia, Republic of (managed float) 1969 3.00 3.57 4.87Kazakhstan, Republic of (pegged to U.S. dollar) 1969 0.00 2.08 7.96Kuwait, State of (pegged to currency basket) 1970 4.37 3.47 7.25Malaysia (managed float) 1970 8.03 15.05 18.65Morocco, Kingdom of (pegged to currency basket) 1974 2.63 3.73 6.49Mozambique, Republic of (managed float) 1974 4.63 4.20 6.88Niger, Republic of (pegged to euro) 1974 3.08 2.29 3.58Nigeria, Federal Republic of (managed float) 1975 4.08 3.29 7.56Pakistan, Federal Democratic Republic of(managed float)

    1976 2.03 2.37 3.57

    Senegal, Republic of (pegged to euro) 1982 4.23 3.68 5.82Sierra Leone, Republic of (pegged to U.S. dollar) 1984 3.73 4.49 9.16Suriname, Republic of (pegged to U.S. dollar) 1992 10.83 12.94 15.20Togo, Republic of (pegged to euro) 1992 3.99 4.06 9.43Tunisia, Republic of (pegged to currency basket) 1994 4.98 7.17 9.09Turkey, Republic of (independent float) 1995 1.36 2.43 5.58Turkmenistan, Republic of (pegged to U.S. dollar) 1995 0.00 6.27 10.32

    Notes: Currency regimes for the OIC are in parentheses and are extracted from International MonetaryFund data (2008), Retrieved from: http://imf.org/external/np/mfd/er/2008/eng/0408.htmSource: Authors calculation based on International Monetary Fund data.

    countries experienced comprehensive trade liberalization and trade reformin the early 1990s, with the removal of quantitative restrictions. Membershave had the intention to promote intraregional trade, and preferentialtrading arrangements (PTAs) with some form of common external tariffs andfreer factor movement have been formed. For example, the autonomous

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    FIGURE1

    Exchan

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  • Exchange Rate Volatility and Regimes on Trade in OICs 187

    trade preference (ATP) scheme provides duty-free and quota-free accessfor member countries exports to the European Union (EU) markets. Forless developed countries, their exports are eligible for duty-free access tothe United States under the Africa Growth and Opportunity Act (AGOA).For instance, countries such as Benin, Burkino Faso, Cote dIvoire, Senegal,Egypt, Guyana, Sierra Leone, and Suriname enjoy benefits from AGOA andenjoy a high utilization rate of 95% for EU and U.S. preferences, whereasothers, such as Niger, Chad, Comoros, Gabon, and Pakistan, have a lowutilization rate of 20% for EU and U.S. preferences. It is noteworthy thattrade growth among the OIC countries is uneven regionally. Growth dispar-ities among members and concerns about trade sanctions have contributedtoward defensive retrogressive trade policies that result in some of the OICmembers lagging behind economically.

    Although the majority of these countries experienced substantialincrease in total trade in recent years, the ratio of trade volume to grossdomestic product (GDP) remains relatively low, and trade growth amongOIC countries is uneven regionally. From Table 1, it is noted that there wasa wide disparity of the ratio of trade to real GDP among OIC countries andthe rest of the world, in which 73% of OIC members generate less than10% of real GDP from trade; and approximately 27% of them constituted10% to 26% of real GDP from trade during the 2000s. Some OIC mem-bers have a more open trade policy regime (e.g., Senegal, Togo, Turkey,and Malaysia), whereas others have a relatively protectionist trade policyregime (e.g., Pakistan and Nigeria). Tariffs vary across member countries,and most OIC members rely on custom duties as their main trade pol-icy instrument. For instance, countries under the West African Communautfinancire dAfrique (Financial Community of Africa; CFA) franc zone (e.g.,Benin) have adopted a maximum tariff of 20%, and countries under CentralAfrican CFA franc zone (e.g., Cameroon, Chad, and Gabon) impose an unfa-vorable maximum tariff of 30%. Meanwhile Central African CFA franc zone(e.g., Mozambique) and countries in the East Asian region (e.g., Indonesiaand Malaysia) have a favorable trading environment with a tariff rate of nomore than 5%. On one end, Bangladesh is one of the most restrictive tradepolicy regimes in the world; whereas on the other end, Egypts more open-trade regime had a duty import on products of only 1.3% on average, whichwas one of the lowest in the world in 2007. Obviously intratrade among OICcountries remains relatively protectionist.

    Export product diversification is uneven among OIC members. Some oil-exporting countries have high export concentration ratios, with oil exportsconstituting a high percentage of total exports in some cases. Guyana is oneof the extreme examples with an integration ratio of 175%, one of the highestin the world. High export concentration index implies the need for productdiversification, and there is a need to reduce barriers among countries fortransactions and make it borderless for movements of inputs and outputs.Countries with low export concentration ratios (e.g., Morocco, Mozambique,

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  • 188 W.-C. Poon and C.-W. Hooy

    and Tunisia) reflect a high degree of diversification. In sum, we can concludethat there is not much progress in promoting inter- or intraregional tradearrangements and promoting trade convergence among OIC members for(1) there is no significant clear-cut gain from trade for members throughregional or multilateral integration, (2) there is insufficient diversification ofexport products among members, and (3) there are insti...

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