Exchange Rate Pass-Through in India an Exploration with Sectoral Import Prices

Abstract

This paper investigates into the degree of exchange rate pass-through to prices of non-oil imports in India during reforms. Exchange rate pass-through (ERPT) is the responsiveness of trade prices (expressed in local currency) to unit change in exchange rate. ERPT is complete if the response in prices is proportional to exchange rate changes and is incomplete if the change in price is less than proportional. The existing empirical literature on the subject provides ample evidence on incomplete pass-through to import prices. Theoretically, incomplete pass-through to import prices is explained in terms of exporters adjusting their mark-ups in order to maintain market shares following currency depreciation. Even though the studies on India have sound theoretical basis, the empirical estimates are weak based on single equation models. In sharp contrast to earlier attempts, a simultaneous equation model incorporating both demand and supply sides is set up for estimation. The reduced form equation for import prices is estimated for disaggregated imports using panel data estimation technique. The empirical results, which are robust, show incomplete exchange rate pass-through to import prices in India. The degree of pass-through is found to vary across commodity groups, the coefficient is found to be insignificant in case of most import sub-sectors with the only exception of chemicals. Further, the estimates show acceptance of fixed effect over random effect indicating sector-specific factors like market concentration and related conduct in determining the degree of exchange rate pass-through to import prices.

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