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12
ECONOMIC ANNALS-XXI
WORLD ECONOMY AND INTERNATIONAL ECONOMIC RELATIONS
Mehtiyev, J., Magda, R., & Vasa, L. / Economic Annals-XXI (2021), 190(5-6(2)), 12-22
Exchange rate impacts on international trade
Abstract
As international trade activities are increased, there are more regulative practices which might be barriers
to trade. One of such hindrances is exchange rate volatility that affects trade activities both directly and
indirectly. Exchange rate volatility of currencies can affect the trade engagements and as well as the trade
balance of a country. One of the implications of the study is that the impacts of monetary policy changes
on trade activities can be noticed significantly in the long-term. While impacts on export levels are usually
immediate, import levels are changed in long-run. The research analyzes the correlation between inflation
and devaluation and clearly states their impacts on trade balance. The case study about devaluation of
the currency of Azerbaijan elaborates the impacts of currency volatility on exports which is illustrated and
analyzed in this research. Moreover, inflation and devaluation correlations and their impacts on import level
of a country are studied through correlation and multiple regression analyses based on the data exported
from OECD and World Bank. The results conclude that exchange rate volatility significantly impacts the
trade balance in terms of imports and exports. Given the results, exchange rate is a non-trade barrier and
affects foreign trade.
Keywords: Devaluation; Exchange Rate; International Trade; Trade Balance
JEL Classification: C10; C34; F10; F18; F20
Acknowledgements and Funding: The authors received no direct funding for this research.
Contribution: The authors contributed equally to this work.
Data Availability Statement: The dataset is available from the authors upon request.
DOI: https://doi.org/10.21003/ea.V190-02
1. Introduction
Nowadays international trade is influenced by many factors, such as tariffs and different trade
policies and actions set by governmental authorities to stimulate national investments and trades.
Economic unions such as European Union are made to better improve international trade by libe-
rating capital flow between countries and reducing restrictions and taxations. However, exchange
rate of capital has also a significant effect on this matter. Exchange rate is strongly correlated with
competing financial markets and therefore with international trade. It can have negative and posi-
tive effects, but it is crucial to create circumstances that sustain this competitiveness (Toderascu &
Firtescu, 2018).
ECONOMIC ANNALS-XXI
ISSN 1728-6239 (Online)
ISSN 1728-6220 (Print)
https://doi.org/10.21003/ea
http://www.soskin.info/ea/
Volume 190 Issue (5-6(2))’2020
Citation information: Mehtiyev, J., Magda, R., & Vasa, L. (2021). Exchange rate impacts on international trade.
Economic Annals-XXI, 190(5-6(2)), 12-22. doi: https://doi.org/10.21003/ea.V190-02
Jalil Mehtiyev
PhD Student (Economics),
Doctoral School of Economic
and Regional Sciences,
Hungarian University of Agriculture
and Life Sciences (MATE)
1 Pater K. Str., Gödöllő, 2100, Hungary
Mehtiyev.Jalil@phd.uni-szie.hu
ORCID ID:
https://orcid.org/0000-0002-8167-348X
Robert Magda
D.Sc. (Economics), Professor,
Doctoral School of Economic and Regional Sciences,
Hungarian University of Agriculture and Life Sciences (MATE)
1 Pater K. Str., Gödöllő, 2100, Hungary
Magda.Robert@uni-mate.hu
Professor, Vanderbijlpark Campus,
North-West University
1174 Hendrick Van Eck Boulevard Vanderbijlpark, 1900, South Africa
ORCID ID: https://orcid.org/0000-0001-9350-6673
László Vasa
D.Sc. (Economics), Professor,
Faculty of Economics,
Széchenyi István University
1 Egyetem Str., Győr, H-9026, Hungary
laszlo.vasa@ifat.hu
ORCID ID:
https://orcid.org/0000-0002-3805-0244
Guest Editor of Economic Annals -XXI
for the Volume 190 Issue (5-6(2))’2021
© Institute of Society Transformation, 2021
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Existence of foreign exchange control system in a country is crucial for trade activity modeling.
However, such a control might end up being a trade hindrance, too. It can be a non-tariff barrier
through leading to artificial currency fluctuations. In addition to the measures that are related to
the flow of goods, policies on the currency which are required for the import of foreign goods may
be implemented. Governments, for instance, want to protect their exports or domestic production
from external competition can keep their exchange rates artificially high. Moreover, they can de-
valuate local currency artificially. Accordingly, foreign goods in the domestic market will be more
expensive and domestic goods will appear cheaper in the foreign market. Thus, the domestic pro-
ducers will be supported as closed and tax will be imposed on the domestic consumers. However,
this policy is very difficult to be sustainable. In order to keep the exchange rate high, central banks
should do certain actions which might affect the trade balance and many other sectors. The stock
of foreign currency reserves is important while having a fixed rate and keeping exchange rate high.
In addition, in reverse scenario which devaluation of local currency, it might lead to inflation in the
local market. For instance, devaluation happened in Azerbaijan in 2015 led to change in trade ba-
lance and inflation. Azerbaijan is an oil exporting country and decrease in the oil prices resulted in
devaluation in the country. Similar economy countries are Algeria, Venezuela, Kuwait. The deva-
luation impacts are studied through the case about Azerbaijan widely in the analysis part of the pa-
per below.
2. Brief Literature Review
Monetary Policy
Economic theory suggests that an economy’s openness to international trade reduces the
abi lity of monetary policy to affect output (Karras, 2001). Furthermore, it also suggests that if
an economy joins a monetary union, it can increase the net benefits. The potency of monetary
policy is depending on to what extent an economy is open for foreign trades. In open econo-
mies, the effect of money on output is supposedly weaker. Considering the effects of a speci-
fic monetary expansion in two different economies: one that is open to foreign trades, and one
that is relatively closed, the outcomes will be different. Even if in both economies the aggregate-
demand is similar, the aggregate-supply will not be. Because of the expected consequent de-
valuation in open eco nomy, the wage demand will grow, and the monetary expansion will be re-
flected on prices and less on the output. Looking at the other economy, the opposite will hap-
pen. Central banks actions are responsive to money in circulation. Monetary policy transmission
to bank lending is determined by income gap and interest rate risk of banks’ exposures. Such
cash flow exposures lead to more robust and transparent responses by central banks (Gomez,
Landier, Sraer, & Thesmar, 2021)
Flexible exchange rate
Flexible Exchange rate proponents stress out that it gives more freedom in terms of trading
compared to fixed exchange rates. Flexible exchange rates are assessed as caring of balance of
payments equilibrium which is based on policy of domestic objectives and without the affection
of external additional factors. Flexible exchange rates heavily rely on the purchasing power parity
(PPP) which is the phenomena contributing to equilibrium of foreign trade. However, it should not
be always relied upon contributing to reduce the PPP gaps.
Inflation and Devaluation
Hypothesis 1 (H1). Inflation over consumer prices has a direct significant impact on devaluation
of a currency.
From a theoretical perspective, in the international trade the unstable and continuous chan-
ges of exchange rate can be seen as a risk since it increases the uncertainty of transactions.
On the other hand, this risk can have a positive effect on exports, meaning that traders, who are
very risk averse might be concerned with the worst possible outcomes, therefore when the risk
increases, they are likely to export more in order to avoid the likelihood of a drastic decrease of
their revenues. In this sense, countries with a lower income are more risk averse, and because
of that they might want to export more. Less risk averse individuals in countries with higher in-
comes have less dependency on such extreme outcomes, thus, when exchange rate risk in-
creases, the vo lume of their exports is likely to get decreased. Increase in exchange risk can
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have substitution and income effects. The substitution effect is that when risk arises the risky
activities become less attractive for some traders, and it results in less exports. On the contra-
ry, the income effect can have a positive impact on exports. When the risk increases, the an-
ticipated utility of export re venue decreases, and this can be balanced by increasing exports.
However, the long- and short-term relationships between foreign trade and exchange rate vo-
latility can be an empirical issue, as it can intensify or diminish through changes in foreign in-
come volatility.
Inflation comes in two ways, through demand-pull and cost-push. Table 1 lists the factors which
play roles to cause inflation for each type.
As shown above, devaluation contributes to cost-pull inflation. Since the prices are likely to go
up in case of devaluation, inflation is yet to happen. At the same time, inflation is an indicator of
devaluation and these two terms are positively correlated. This statement in H1 is analyzed and
proven in analyses section.
There are two types of currency devaluations. One of them is the gradual, which happens gra-
dually and credibly, and the other is the big bang, which is a massive, extraordinary devaluation.
Gradual devaluation seemingly has better outcomes. After a gradual devaluation happens, the
trade balance of the affected economies tends to improve, as the economies will have to handle
only slowly developing changes in relative prices. In the long-run, possible further exchange rate
adjustments might be expected. However, the outcome of any gradual devaluation is also de-
pending on the earliest conditions of a country (Nguyen & Geiger, 2018).
In comparison with the previous, the big bang devaluation is shocking the economy and se-
veral challenges are coming alongside with it causing long term effects. What happens is that
while the trade balance of an economy is improving the exports do not increase. It can also
be connected to the drop of GDP and investments, as during bad economic periods countries
are forced to deliver a large level of exchange rate adjustments. It interrupts international trade
as exported pro ducts become cheaper unexpectedly, while the price of imports suddenly in-
creases (Segal, 2020). Moreover, a rapid and sharp devaluation will increase the value of foreign
debts, especially if it is counted in US dollar. On condition that a domestic bank is dollar-based,
then this can also possibly lead to banking crisis that can end up in rejecting further investments.
A key advantage for big-bang devaluation is that it does not reinforce expectations for further
rounds of depreciations.
Devaluation leads to a decrease in the value of a currency hence it is likely to contribute
to inflation. Devaluation makes importing more expensive and therefore causes an increased
compe titiveness and higher demand in exporting (Pettinger, 2017). As the price level drops, in-
terest rates fall, domestic investment in foreign countries increases, the real exchange rate de-
preciates, net exports increase, and aggregate demand increases. Devaluation of a currency
increases inflation, and for this reason imports become more expensive. It leads to more com-
petitive exports, and as exports increase it causes demand-pull inflation. Devaluation of a cur-
rency makes exports more competitive, and at the same time makes imports more expensive. A
higher demand for exports boosts an economy’s growth, as more pricey imports will encou rage
inhabitants to find local alternatives instead of imported products. Moreover, if devaluation hap-
pens in a country, it decreases the costs of the economy’s exports and increases the costs of
imports. Therefore, locals are less likely to purchase imported products, which further streng-
thens domestic businesses.
On the other hand, inflation affects the cost of living in a country, as well as making busines-
ses, government bond yields, money borrowing, mortgages, and many other facets of an eco-
nomy. Inflation can be both beneficial and might have negative impacts (Davis, 2019). If consu mer
Table 1:
Factors of inflation
Source: The American Economic Review (1960)
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spending grows to a point when demand exceeds supply, inflation may occur. The higher the in-
terest rates in an economy, the more attractive it becomes for foreign investors, which is likely
to increase the need for the country’s national currency. Inflation benefits borrowers in terms of
allowing them to pay lenders back with money with less value than it had when borrowed. On the
other hand, when inflation results higher prices, the demand for credit grows, it benefits lenders
(Segal, 2020).
As mentioned above, devaluation increases the prices of import products and boosts the
domestic demand, and it may be driven due to several reasons. One of them is demand-pull in-
flation: the aggregate demand increases faster than the aggregate supply. On the other hand,
there is cost-push inflation: It happens, for instance, higher oil prices feeding through into
higher costs.
When a government wants to increase its balance in trade, they can decrease the relative va-
lue of their national currency by adjusting the exchange rate of its currency in opposition to that of
another country. The economy’s exports become more attractive for foreign traders, as they get
cheaper. A higher demand for exports results in an improvement in the current account deficit,
and moreover, it leads to a higher rate of economic growth (Vásáry et al., 2013; Pettinger, 2019;
Cubillos et al., 2021).
Exchange Rate Implications and Foreign Trade
Hypothesis 2 (H2). Export level (trade balance) impacts exchange rate of a currency.
To better understand the effects of exchange rate on international trade and trade policy, many
researches have been established. However, despite the increasing number of studies, this topic
still remains an open question.
Exchange rate volatility is one of the many aspects of the relation between exchange rates
and trade that this research examines. An increase in exchange rate volatility would cause less
interest in international trade, as there are various risks, such as transaction costs, that have to
be taken into consideration. The relationship between these two is mostly driven by emphasi-
zing long-term policy credibility rather than the short-term conditions. Although, as nowadays
there are many different financial instruments available such as forward contract and currency
options, the risks associated with exchange rate volatility can easily be mitigated. In this case,
volatility is not always a critical issue for international trade, moreover, trade flow can stabilize
exchange rate fluctuations, thus reducing volatility (Broda and Romalis, 2010). Furthermore, in
modern international transactions traders are more likely to offset the risks of any adverse price
movements, or as part of their export strategy, bear with the costs coming along with possible
exchange rate fluctuations.
Another aspect of the relationship between exchange rate and international trade is currency
misalignment, which is mainly driven by its effect on relative import prices. Relative prices mean
that in a short term they respond to the movement of exchange rate. If a national currency is de-
preciated, it increases the competitiveness of the export sectors. In this sense the impacts of cur-
rency misalignments on prices are similar to the effects of export subsidy and import tax. Yet, there
is another issue that largely complicate the relationship between international trade and exchange
rate misalignment (Nicita, 2013). It is that usually part of the fluctuation of exchange rate is ab-
sorbed by international traders that do not wish to fully adjust their prices in the destination coun-
try. Also, the sunken costs of entry highly motivate firms to stay in the trade market even if there is
significant undervaluation of the importer currency.
The other issue on the relationship between exchange rates and international trade is the ef-
fect of exchange rate misalignments on trade policy. Exchange rate may indirectly impact go-
vernments’ decisions regarding international trade policies. For instance, based on recent stu-
dies, if exchange rates are overvalued for a long period, it increases the use of protectionist trade
policies. However, domestic firms that have lost competitiveness due to the appreciation of real
exchange rates may turn to restrictive trade policies. Thus, disputes over exchange rate policies
among international traders can increase domestic political pressures. In general, countries might
use trade policy as a proxy for exchange rate overvaluation, so as to deal with persistent unba-
lance in the trade balance (UN, 2013).
Exchange rate misalignments cannot give a full explanation for global imbalances, however,
they do have a considerable effects on international trade flow. While currency depreciation pro-
motes exports and restricts imports, currency appreciation causes the opposite (Hayes, 2019).
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Furthermore, even though exchange rate volatility is not a major concern in trade policy, some
countries can use trade policy to recompense some of the consequences of an overvalued cur-
rency. However, policymakers should pay attention to exchange rates of their own countries and
also those of other countries. They should monitor their exchange rates relative not only to that of
their trading partners, but also to that of their competitors (UN, 2013).
To conclude, exchange rate adjustments must be accompanied by other trading policy actions
for global rebalancing, and strategies should
Volatility Impacts
Hypothesis 3 (H3). Exchange rate of a currency has significant impact on the trade balance
of the country.
The economic crisis had an impact on the world economies, affected the trading system and
changed economic trade patterns. It created a low employment in countries, and depreciation
came along with it, which caused the exports to become cheaper and imports to become more
costly. For this reason, it pushed policymakers to stimulate their exports in the hope of improving
their trade and account balances. Policymakers with such interests had to have a better look at the
fluctuation of the exchange rate. However, what must be taken into consideration is that exported
products also contain a large proportion of imported components, and are not always substitu-
table with domestic products.
Furthermore, exchange rate levels have an important impact on investment flows. When a
country’s currency is depreciated, it is in favor of foreign investors, as capital investments be-
come cheaper for them, which is particularly important for large economies.
Exchange rate volatility affects firms differently in a country. Firms have to deal with numerous
economic and commercial risks when engaging in international trade. There are risk management
tools available for firms to mitigate the impacts of the risks. However, these complex tools may not
be available for all firms, as using them have a significant cost, plus they might not cover all finan-
cial and commercial functionings (OECD, 2011).
Many papers have analysed the impacts of exchange rate volatility on international trade,
but so far no consensus has been reached regarding this topic. Although, there is a common
understanding as to the direction of effect of the exchange rate on bilateral flows (imports and
exports).
There have been many models and theoretical studies made in literature about how exchange
rate volatility may affect international trade. One of the most mentioned negative relationship bet-
ween exchange rate volatility and trade is coming from transaction costs. It is shown that the con-
version costs from one currency to another and the risk associated with probable exchange rate
changes are both having a reducing effect on trade flows. To clarify, if exchange rate risk is in-
creasing, then the volume of trade will decrease, if the traders are risk averse.
On the other hand, some studies are questioning the negative effects of exchange rate variabi-
lity on trade. According to De Grauwe (1988), depending on how risk averse traders are, exchange
rate volatility may have either a negative or positive impact. It suggests that there are two opposing
effects that shape the impact of exchange rate volatility: the substitution effect or income effect. By
substitution effect the uncertainty of firms towards exchange rate risks reduces the trade flows. On
the other hand, by income effect companies will increase international trades in order to offset a de-
cline in total expected utility.
Other studies indicate that more risk averse firms are more likely to hedge against future ex-
change rate changes. Thus, they will apply a risk premium to cover the costs of exchange rate vo-
latility. However, hedging involves high costs and some limitations such as complexity for firms to
predict the volume and timing of their transactions (Kharroubi, 2011).
Studies look more into the reach of the traders, national and multinational companies. They as-
sume that multinational firms that are producing in foreign countries and selling products abroad
have monopoly power in the international market and are facing exchange rate uncertainty. If ex-
change rate risk is not hedged, then productions will decrease in the foreign country.
To sum up, the impacts of exchange rate volatility on trade is ambiguous: they can be both po-
sitive or negative, and are strongly depending on transaction delays, and also on the behaviour of
traders facing increased risks.
In agriculture many production decisions are taken well in advance, and there is a general uncer-
tainty regarding the final pricing of the products. Therefore, price volatility is one of the main risks
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in this sector. Exchange rate volatility also has a significant impact in this matter, as it can affect the
transmission from world prices to domestic prices. For instance, indicate that most of the world’s
grain trade is denominated in US dollars, which may introduce an additional transaction cost if
both exporter and importer are located outside the United States but the goods are denominated
in US dollars (OECD, 2011).
In the last decades numerous empirical studies have been made, and based on varied funda-
mental assumptions the researches show that there are positive, negative or no effect of exchange
rate volatility on the volume of international trade. The studies also analyze the effect of both the
level and volatility of exchange rate on trade, in a single equation or in a set of equations. Results
vary, depending on the time period taken into consideration, whether short-, or long-term effects
are examined, the measure of variability, and also whether or not effects are analyzed at an aggre-
gate, sectoral or at a product level. Furthermore, some researches that study the impacts in dif-
ferent sectors find that trade in some products responds to exchange rate movements positively,
and in some other cases negatively, which demonstrates that the net effect is strongly depending
on the composition of exported and imported goods.
Exchange rate volatility is directly affected by monetary policy as well as government actions.
Recent proof of it is that as a result of COVID-19 pandemic, government interventions on several
economic and social fields have been increased. The more confirmed cases, the stricter various
responses adopted by governments. Confirmed cases have significant impacts on exchange rate
volatility. On the other hand, the economic policies actioned by governments during the pande-
mic, including fiscal measures, income support and aid have a restraining effect on exchange rate
volatility (Feng, Yang, Gong, & Chang, 2021)
To conclude, in the literature regarding this topic, vast amount of the studies find negative im-
pacts of exchange rate fluctuations on trade, while some others do not find any crucial effect. In
the long run, some industries such as agriculture exports are greatly impacted by the exchange
rate negatively. In addition, in the short run exchange rate is found to have significant impacts on
both exports and imports. All in all, the effect of exchange rate volatility impacts may vary across
industries and different business sectors, as they can have different trade policies and concentra-
tions levels in different industries.
3. Methodology
In order to prove the hypotheses empirically, two different ways are approached. One is rela ted to
devaluation and dependency of an economy based on a real life case study about Azerbaijan. The
study clearly indicates the impacts of a devaluation on foreign trade and trade balance in the recent
history - 2015. This case study mainly shows the impacts of devaluation on export level of Azerbai-
jan. The historical data for Azerbaijan imports and exports, retrieved from UN database is used to
elaborate the case study. Through the study, the reactions of Central Bank of Azerbaijan and other
authorities and consequently changes in trade balance are clearly indicated and illustrated.
The other analysis method run in this research is correlation and multiple regression. Inflation
and devaluation relations and their impacts on trade balance are discussed and illustrated. Infla-
tion affects devaluation and consequently long term impacts of this are clearly indicated. Data for
a set of countries is retrieved from OECD and World Bank databases. Total imports, exports, infla-
tion rates for 2019 and exchange rates against USD for 2018 and 2019 are gathered. Through the
Microsoft Office tool - Excel, with using formulas on average exchange rates for countries deva-
luation in percentage terms for each country for 2019 is identified. The formula used for devalua-
tion rates is below:
(xr 2 - xr 1) / xr 2 , (1)
where:
xr 1 is average exchange rate in 2018;
xr 2 is average exchange rate in 2019.
Once inflation and devaluation data clarified, the data is imported on SPSS to run regression
and correlation analyses. To find out if inflation significantly predicts devaluation, the regression
analyses between these two variables is run. Then, correlations between inflation, devaluation.
and import levels of countries are identified.
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Analyses
The analysis part of the study is encouraged by the above discussed literature and even though
there have been many papers about exchange rates and foreign trade, this study shows different
aspects of foreign trade. In the literature, monetary policy, exchange rate volatility, inflation, deva-
luation are discussed. Hypothesises are elaborated through the literature and proven through be-
low case study and statistical and economic equations.
The Case of Azerbaijan
In February 2015, the Azerbaijani national currency deflated against US dollar for the first time
since 2006. The exchange rate from dollar to manat which is national currency of the country was
33.86% higher compared to the rate set prior to the depreciation process.
Since oil prices in the world market dropped in 2014, the Central Bank of Azerbaijan had been in
dilemma whether to go for a gradual or for a sharp devaluation of manat. Indeed, what happened
one year later undermined the reputation of the Central Bank and the whole banking system, as
the government promised a gradual devaluation to slowly reach goals which they had laid out. It
would increase the Bank’s costs to take action, plus the budget revenues in manat. However, as
long as the crude oil’s price was low, a less than 30.0% devaluation would not be enough to cover
the state budget’s shortage, and for this reason the Central Bank decided to have a sharp deva-
luation of the national currency (CESD, 2015).
Some of the main reasons why the government decided next to a sharp and deep devaluation:
Fiscal reason
In 2015, 65.0% of the total income of Azerbaijan was generated by SOFAZ (State Oil Fund
of Azerbaijan). Although the monthly oil exports had not been reduced, but when the oil prices
dropped in the world market, the income of exports had dramatically decreased. This had a ne-
gative effect on the economy, as the state was heavily dependent on oil and natural gas exports.
Still, the government could take advantage of the devaluation, as with the previous exchange rate
the state had to transfer USD 2.91 billion to the total budget in oil money, while after devaluation of
their national currency this amount decreased to USD 2.15 billion. In this case only from direct oil
income the government was able to save USD 760 million (CESD, 2015).
Saving the money of SOFAZ
An important fact is that while the revenue of SOFAZ is in US dollars, the costs and spendings
are in manat. Therefore, devaluation of exchange rate helped the government to save billions of
US dollars in 2015, and that SOFAZ was able to reach its fiscal targets for that year.
Lowering the decrease of Central Bank’s savings
After the Central Bank’s announcement about the future devaluation the demand for US dol-
lar in the country dramatically increased. It caused the investors to withdraw their deposits from
the bank and the share of manat deposits decreased from 63.0% to 45.0%. To further post-
pone the devaluation would had resulted in losing all of the Central Bank’s reserves within a few
months.
Promoting other export possibilities instead of oil
The share of non-oil products in total exports has been very low with the rate of 5.0%. Govern-
ment decided that in a long-term period the main priority should be an economic diversification.
Besides, Azerbaijan’s main trade partners’ currencies had also been devaluated, therefore ex-
porting non-oil products to those countries became more expensive in US dollar terms.
Increasing the GDP in manat (AZN) terms
The devaluation of Azerbaijanian currency against US dollar increased the GDP in manat
terms. However, the growth of exports of some non-oil products did not bring a real econo-
mic improvement for the country in the short-term. Thus, there has been more focus on agri-
culture, specifically on cotton. Government supports farmers with aids and incentives to en-
courage the growth and exports (Huseynov, Jafarov, Vermeer, & Gaplaev, 2021). Long-term
impacts of export diversification have been more robust and lead to increase of export level of
non-oil sectors.
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Boosting the inflation rate
According to Economic and Social Development Center, Import prices had also grown which
resulted in the increase in inflation. The Central Bank of Azerbaijan had been pushing the inflation
rate to promote local and foreign investments to the state’s economy.
The other important reason that Azerbaijan faced vast currency devaluation in 2015 was rela-
ted to gradual economic decline since 2011. Azerbaijan economy was facing gradual decline since
2011 even though the oil prices was stable and even slightly increased. The huge share of Azer-
baijan’s economy is dependent on oil as the country is opulent with natural resources including
crude oil. In 2015, the oil prices significantly decreased with an average decrease of 48% in price
in comparison to prices in 2014. This was the main reason of economic downturn as the econo-
my is dependent on oil exports mainly. Central Bank of Azerbaijan took regulatory action to sus-
tain and improve economic stability in the country. Thus, the currency was devaluated. There were
impacts on many economic fields, however, the foremost impact was on international trade activi-
ties. Table 2 shows the total exports and imports of goods for the years of 2008-2020.
As shown on above table, the total exports of goods amount was decreased to USD 11.3 bil-
lion in 2015 which is more than 2 times less in comparison to previous years. Similar scenario hap-
pened in 2009 which was due to decrease of oil prices, too. No regulatory action was taken by
Central Bank at that time; however, some fiscal actions were taken by the government. In the fol-
lowing year after the decline, the oil prices increased which resulted in increase in exports.
The exporters were encouraged through the action of devaluation by Central Bank to engage
in more trade activities. Furthermore, there was a focus by government on some other industries
such as agriculture and tourism apart from oil industry. Subsidies were provided to infant and less
developed industries by the government. Consequently, the number of exporting products and
businesses increased as they could generate more local currency. If we look at the import level of
the country after devaluation, there is no significant change. The imports got decreased right after
devaluation slightly as products became more expensive in local currency. However, in upcoming
years, imports are increased again. This can be explained by economic and expansion and infla-
tion. Both monetary (devaluation) and fiscal (focus on non-oil industries) regulatory actions pre-
vented economic decline and improved international trade activities of Azerbaijan. Based on UN
Comtrade (2021) data, in 2020, trade balance - both imports and exports of the country has been
decreased due to global pandemic.
4.2. Inflation & Devaluation Analysis
In order to find out if inflation significantly predicts devaluation, regression analysis can be ap-
proached. Using SPSS software, multiple regression analysis was run. Devaluation rate is taken
as dependent variable while inflation rate as independent variables. The number of the countries
with valid data is 130.
The data is exported from of World Bank and OECD database. 182 countries are reflected and
the data is for the year of 2019. Using the SPSS software, binary regression and correlation analy-
ses were used to build various models to ascertain their predictive values.
Table 2:
Total exports and imports of goods for the years of 2008-2020 in Azerbaijan
Source: UN Comtrade, TrendEconomy (2021)
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The analysis finds out that the value of our model (p value) is 0.000 (0.000037). The confidence
level in the analysis is 95%. The model is statistically significant since the p value is less than 0.05.
So, the null hypothesis is rejected. In other words, inflation rate predicts devaluation rate. Signifi-
cance model is reported as below:
F (1,128) = 139.799, p = 0.000 . (2)
Moreover, in the analysis, the model summary indicates the adjusted R square value is 0.518
meaning that 51% of the variance in devaluation rate can be explained by inflation rate. The model
summary that illustrates mentioned above is given in Table 3.
In the model, slope coefficient is 0.625. The equation of line for using inflation rate to predict
devaluation rate is as below:
y = m x + b . (3)
Here, m is the slope and b is constant. y indicates dependent variable (devaluation rate) while x
is independent variable (inflation rate). Thus, the mathematical equations of our model are as fol-
lows:
Y = 0.625 X + 2.670 . (4)
Correlations
The correlation coefficient is determined by dividing the covariance by the product of the two
variables’ standard deviations. Standard deviation is a measure of the dispersion of data from its
average (Ganti, 2020). Correlation coefficients are used to measure the strength and direction of
a linear relationship between two variables.
The model to find out the correlation coefficient is as follows:
ρxy = Cov (x,y) / σx σy , (5)
where:
ρxy is Pearson product-moment correlation coefficient;
Cov (x,y) is covariance of variables x and y;
σx is standard deviation of x;
σy is standard deviation of y .
After running the analysis, we can conclude that inflation rate has positive correlation with de-
valuation rate (Table 4). The Pearson Correlation coefficient between inflation and devaluation
rates is 0.723 which is higher than 0.5 and very close to 0.75, therefore it can be considered as
high degree of correlation. Below is the correlations table exported from SPSS.
Moreover, on the same data, correlation analysis was run to identify the relationship of infla-
tion with imports. The correlation coefficients between inflation rate-imports and devaluation
rate-imports are -0.085 and -0.057 respectively. The analysis concludes that there are no cor-
relations between these variables. However, if we ran the same analysis for the same set of data
for diffe rent (further) years, we get different results. For instance, analyzing inflation and deva-
luation rates for 2018 and import rate change from 2018 to 2019, resulted in different coefficients.
The correlation coefficients between inflation rate and imports; devaluation rate and imports are
Table 3:
Model summary
Source: Calculated by authors by using SPSS
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-0.218 and -0.201, respectively. These correlations are not considered signi ficant, however, it
differs significantly than same year data analysis. The reasonable explanation for such relation is
that inflation and devaluation in a country affects trade activities in the following years, in other
words, in long-term. The implication is that the impact of monetary policy changes on trade ac-
tivities can be noticed in the long-run. There might be impacts in the same year, however, the
main effects will be visible in the future. The reason is that a mo netary policy is applied based on
the current situations with the aim of long term adjustments and predictions.
5. Results
The empirical results of the study prove that the exchange rate significantly impacts internatio-
nal trade. In this regard, companies as well as governments can formulate trade activities by
keeping in view that exchange rate volatility affect on overseas trading.
The practical implication of the study suggests that the strength of a currency is strongly de-
pendent on the export level which was discussed through hypothesis 2 and 3 (H2; H3). Thus, a
country’s export level should not be dependent on one industry but should be diversified and in-
vested in broad range of industries in order to avoid the risk of collapse of the currency in down-
turn of that only industry. Hence, governments should get involved in monitoring and encouraging
the investors in different fields that have potential growth.
The hypothesis 1 (H1) questioned that consumer price inflation leads to devaluation. The state-
ment is proven through empirical results. The implication is that in order to keep the exchange rate
volatility in balance, the inflation should be kept in the loop. Central Banks are the main role players
to monitor this. In case inflation goes up, in the long run devaluation is undeniable. Consequently,
such a process leads to change of trade balance.
6. Conclusion
Foreign exchange control is an important factor in a country to its trade activities. Considering
the analyzed impacts, it can be considered one of the most important factors in international trade
activities. Exchange rate issue is a non-tariff barrier. Because it might affect the trade indirectly, it
is considered non-trade barrier in some sense. To sum up, the impacts of exchange rates on in-
ternational trade is ambiguous: they can be both positive or negative, and are strongly depending
on transaction terms, and also on the behaviour of trading countries. Even though exchange rate
applications are introduced with different objectives by Central Banks, certainly, it will have indirect
effects on international trade activities and balance. All in all, I consider in any type of currency ap-
plications, the trade balance should be taken into consideration and prioritized.
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Received 27.04.2021
Received in revised form 12.05.2021
Accepted 20.05.2021
Available online 10.07.2021
