Estimating the Effects of Exchange Rate changes on Production, Investment and Trade in Industrial Sector

Since the end of the Iraqi imposed war, the Iranian economy has experienced several foreign exchange rate shocks with impacts on different sectors of the economy. In every foreign exchange shock, policy and decision makers face two fundamental questions: First, what are the effects of foreign exchange rate changes on major variables of the industrial sector? And second, which industrial fields of activity gain and which lose from such changes?

The findings of the research show that a proper foreign exchange policy is an important element of industrial development along with other industrial policies. The key to the currency policy is to avoid setting artificial exchange rates and to be committed to maintaining a competitive exchange rate aiming at ensuring the competitiveness of domestic products. However, this policy should be seen as a complementary one. The prices in the industrial sector do not increase at the same rate as the foreign exchange rate increases. On the other hand, in most industries, increases in foreign exchange rate do not exactly match the increases in the prices of industrial products. However, in the automotive industry, increases in prices correspond to foreign exchange price increases. This can be attributed to various factors, most notable among them being the fact that the automotive industry is less exposed to foreign competition. Dependence on imported capital equipment and consumer products, as well as government pricing policies that lead to stickiness in prices, also play an important role in different reactions of various industries to changing foreign exchange rates.

The results also show that, in general, key variables in Iran's various industries are significantly sensitive to foreign exchange policy. This shows that an appropriate foreign exchange rate policy can effectively stimulate these variables. The policy of fixing the nominal foreign exchange rate will have negative effects on exports, production and investment variables, and will increase industrial imports. The proper policy seems to be stabilizing the real foreign exchange rate.

The findings of the study show that the common perception that protectionism can increase industrial growth and exports is not much correct. On the contrary, exports and production were higher in industries that were more exposed to foreign competition. Of course, this policy should be pursued alongside the policy of stabilizing the real foreign exchange rate. Otherwise, if the policy of fixing the nominal foreign exchange rate is followed, exposure to foreign competition will ultimately lead to the collapse of the industry.

The findings show that large industries as well as export industries, as compared with other industries, have shown less sensitivity to foreign exchange policy, although this sensitivity is not small and insignificant. Therefore, diversifying the industries and devising incentive packages for other industries, in particular, those with higher value added, can also increase the positive impact of foreign exchange policies on the industrial sector.

According to the research findings, the following policy strategies are proposed, in order to apply an appropriate foreign exchange policy for the industry sector:

  • Following the policy of stabilizing the real foreign exchange rate and avoiding the policy of fixing the nominal foreign exchange rate;
  • Avoiding the extreme protection of industries and making domestic industries more competitive;
  • Diversifying the industrial structure through encouraging investment; and
  • Controlling inflation by controlling monetary variables.
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