Exchange rate pass‐through to import prices: Evidence from a heterogeneous panel of West African countries

• Published date: 01 November 2021
• Author: Mohamed Tidjane Kinda,Hamidou Barry
• Date: 01 November 2021
• DOI: http://doi.org/10.1111/rode.12803

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wileyonlinelibrary.com/journal/rode Rev Dev Econ. 2021;25:2454–2472.

© 2021 John Wiley & Sons Ltd

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INTRODUCTION

The impact of exchange rate movements is crucial for small extroverted economies. As these econ-

omies are dependent on international trade, they are vulnerable to the transmission of exchange rate

shocks to the domestic prices of goods and services. In the literature, this transmission is known as

exchange rate pass- through (ERPT). Exchange rate volatility can, in fact, be transmitted to domestic

Received: 26 August 2020

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Revised: 15 May 2021

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Accepted: 17 May 2021

DOI: 10.1111/rode.12803

REGULAR ARTICLE

Exchange rate pass- through to import prices:

Evidence from a heterogeneous panel of West

African countries

Mohamed TidjaneKinda1

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HamidouBarry2

1Institut Burkinabè des Arts et Métiers

(IBAM), University Joseph KI- ZERBO,

Ouagadougou, Burkina Faso

2Department of Economics, University

Général Lansana Conté de Sonfonia-

Conakry, Conakry, Guinea

Correspondence

Mohamed Tidjane Kinda, Institut

Burkinabè des Arts et Métiers (IBAM),

University Joseph KI- ZERBO,

Ouagadougou, Burkina Faso.

Email: kindatidjane@yahoo.fr

Abstract

This study analyzes the effect of exchange rate pass- through

(ERPT) on the import prices of West African countries. We

used a heterogeneous dynamic panel over the period 1991–

2018 and estimated the ERPT using the pooled mean group,

mean group, and augmented mean group. The results show

that an exchange rate appreciation of 1% in the short term

leads to a decrease in the price of imports by 0.25% and

0.20%, respectively, for the West African Economic and

Monetary Union (WAEMU) countries and those outside the

WAEMU zone. However, considering other countries, we

find that the ERPT has a long- term effect and causes a rise

in import prices of 0.83%. This effect depends on the level

of inflation. Thus, the pass- through effect appears to be

heterogeneous across countries.

KEYWORDS

exchange rate, heterogeneous panel, import prices, inflation,

pass- through

JEL CLASSIFICATION

C23; E31; F31; F41; G15

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KINDA AND BARRY

prices through imports of consumption goods, production goods, or exports (An & Wang,2012;

Sahminan,2002).

Many factors can explain pass- through (An & Wang,2012). These factors include the sensitivity

of corporate profits or margins to exchange rate movements, returns to scale, elasticity of demand for

imported or exported goods, structure of the domestic market, and stability of monetary policy (Ben

Cheikh & Raoult, 2017; Bouakez & Rebei,2008; Ca'Zorzi et al., 2007; Coulibaly & Kempf,2010;

Devereux etal.,2003; Taylor,2000). They play an important role in the ability of countries to cope

with exchange rate shocks.

Factors such as market structure and the degree of product differentiation can also lead to incom-

plete or partial pass- through by favoring certain firms’ strategic behaviors (Byrne et al., 2010). For

example, it has been empirically proven that the choice of currency in which imports are invoiced

can have a definite effect on pass- through. In international goods transactions, firms can choose to

invoice either in the importer's currency (local currency pricing, LCP) or in the producer's currency

(PCP; Engle, 2006). This option is strongly influenced by the stability differential between the two

currencies. Thus, this option remains important, especially in the presence of nominal price rigidities,

as a two- way relationship exists between exchange rate volatility and the conversion of that rate to

prices (Corsetti & Pesenti,2004; Devereux etal.,2003; Gopinath etal.,2010). Thus, the more volatile

the exchange rate, the higher the number of exporting firms opting for the PCP option to minimize

the effects of this volatility on prices. However, this type of behavior may increase the volatility of the

importer's currency and ultimately create pass- through in the par tner country, which could lead to a

potential loss of market share for these firms.

Assuming that export prices are determined by a markup over marginal costs, the import price

elasticity with respect to the exchange rate depends on the exporters’ pricing strategies. If exporters

choose to absorb exchange rate fluctuations into their markup, a strategy also known as LCP or pricing

to market (PTM), then import prices remain largely unaffected by exchange rate shocks and the ERPT

is considered incomplete. Conversely, if exporters choose not to adjust their markup, then exchange

rate fluctuations are fully reflected in import prices, which is known as PCP. In this case, ERPT is

considered complete. Within an imperfect competition market, exporters can practice a PTM strategy

by setting different prices for various destination markets. If firms have a constant markup, import

prices move one- to- one to changes in exchange rates, and evidence of PTM does not exist. The latter

case refers to the denomination of imports in the currency of the exporting country, known as PCP.

However, if the firm's markup decreases following destination market currency depreciation, PTM

occurs, and pass- through to import pr ices is less than complete. Meanwhile, when prices do not vary

in the currency of the importing country, this refers to the LCP strategy, and pass- through is equal to

zero.

The strategic behaviors of firms highlight the existence of nominal rigidities that often lead to price

viscosity in the international market for goods and services. They also highlight the seminal relation-

ship between pass- through and the monetary policy of various countries open to international trade

(Devereux etal.,2003). Indeed, the success of monetary policy dur ing the past decade depends on

controlling the degree of pass- through and its long- term dynamics (Edwards, 2006; Gagnon & Lhrig,

2004; Mishkin,2008).

Several methods have been used to investigate the impact of ERPT on import prices. Indeed,

Barhoumi (2006) examines the pass- through of exchange rates to import prices in a sample of 24

developing countries from 1980 to 2003. He used non- stationary panel estimation methods. These

methods are based on mean group (MG), pooled mean group (PMG), fully modified ordinary least

squares, and dynamic ordinary least squares estimators. The results of this particular study indicate

that most of the differences in the pass- through of the exchange rate to import prices are due to three