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Choudri, Ehsan U., D. S. Hakura, 2001, “Exchange Rate Pass-Through to Domestic Prices: Does the Inflationary Environment Matter?” IMF Working Paper 01/194, Washington, International Monetary Fund.
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The parallel market in Iran has been an amalgam of several active and closely linked markets, including the offshore market located at Dubai (used mainly for transferring worker’s remittances from abroad), an officially recognized parallel market operated by domestic commercial banks until the March 2002 unification (used for transactions associated with local foreign currency holdings sourced from abroad and services transactions) and the illegal curb market. With strong oil export revenues and import liberalization from 2000/01 onwards, most current account transactions were shifted to official markets, and parallel market transactions are likely to have been mainly restricted to certain capital market activities, as evidenced by the decline in the premium of the parallel market exchange rate over official market rates.
Imports of necessities include pharmaceutical products, medical appliances, certain services, fertilizers, defense items, scholarships, and capital goods for the state-owned enterprises.
Levy-Yeyati and Sturzenegger (2002) also present cross-country econometric evidence that for developing countries, greater exchange rate flexibility is strongly associated with higher growth and less output volatility.
The fact that Iran had multiple exchange rates during the past decade complicates the interpretation of real exchange rate movements and their relation with other economic variables. Figure 1-5 charts the evolution of the Iranian crude oil price and the U.S.-Iran CPI based bilateral real exchange rate, based on the parallel market exchange rate, to capture the direction of change of a market based measure of the real exchange rate against changes in real government expenditure. This measure of the real exchange rate is used due to the availability of the required data for a long time period, and since it gives a good indication of how the real exchange rate would have behaved had there been a single, floating exchange rate, as proxied by the parallel market exchange rate.
See Davis, Ossowski, Daniel, and Barnett (2001) on the use of stabilization funds in dealing with the economic consequences of natural resource booms.
The prediction that nominal exchange rate fluctuations could effectively bring about the desired alterations in the real exchange rate is based on the premise that real wages are reasonably flexible in Iran, as evidenced by the sizable fluctuations in real wages over the past decade, as well as the lack of any independent labor organizations and labor unions.
The stability of the TSE and parallel market exchange rates made possible by the abundance of oil revenues since 2000/01, the high rates of return on domestic financial instruments such as the Central Bank Participation Papers (CPPs) and the reduction in inflation in the recent years may have reduced the extent of currency substitution and the importance of the parallel market rate in the formation of inflationary expectations. However, no statistically significant break was detected for the relationship between inflation and its determinants from 1990/91-2001/02, including the parallel market depreciation, suggesting that a potential reduction in supply to the foreign currency market and a parallel market depreciation can rapidly increase inflation.
Choudri and Hakura (2001) present empirical evidence that the pass-through of exchange rate movements into inflation is more rapid and larger in high inflation environments.