Exchange Rate Volatility Impact on Indonesian Pepper Export Performance

Abstract

Since the breakdown of Bretton Woods system in 1973, topic on the impact of exchange rate volatility on trade has been drawn attention of many researchers. However, discussion on the topic remains ambiguous and becomes an empirical issue. Indonesia is an emerging country that heavily depends on agricultural export as one of its national income sources. As Indonesia’s agricultural trade has become largely integrated with global trade, it inevitably involves other currencies on its transactions. Pepper (Piper nigrum) is one of the most exported spices in Indonesia followed by cinnamon, cloves, and vanilla. Due to its strong dependency on international trade, Indonesian pepper exports are suspected to be prone to exchange rate volatility risks. This paper aims to analyze the exchange rate volatility and examine the relationship between bilateral exchange rate volatility from 2005 to 2019 using the gravity model and GARCH(1,1) model as the proxy of exchange rate volatility.

The results of bilateral exchange rate volatility analysis versus Indonesia’s pepper trading partners indicate that the highest volatility for all of the currencies occurred between 2008 and 2009 due to the recent financial crisis or GFC. Amidst the shock, Indonesia was reported to have resilient growth. The results of the gravity model reveal that during the observation period, Indonesian pepper exports are not affected significantly by the exchange rate volatility. This is because Indonesia has been in the position as a net exporter of pepper where a majority of its production is consumed abroad. Moreover, pepper only costs a small percentage of the total cost of food productions. Since pepper is included as necessity goods, pepper demand is relatively not responsive to the price changes (inelastic). Therefore, the effects are not large enough to affect Indonesian pepper exports.

Pepper has a good opportunity for export expansion since the results suggest that it is resistant to exchange rate volatility risks. To support this, the efforts that can be used are to maintain the currency stability, support on providing hedging facilities, and optimize the application of warehouse receipt system (WRS) for the better competitiveness. For future research, it is recommended to use more data in the analysis and try to use other variables that may be related to this topic. Finally, it is also recommended to compare the results with other volatility measurements.