This study examines the impact of exchange rate volatility on Indonesia’s primary export commodities to the top five export destination countries, namely China, India, Japan, South Korea, and the United States. This study uses a GARCH model to obtain an estimated value of exchange rate volatility, using monthly data covering from 2006 to 2018. The ARDL method helps to measure the effect of exchange rate volatility on exports to destination countries in both the short and the long-term. Aggregate exports are compared employing a linear (ARDL) and a non-linear autoregressive distributed lag model (NARDL). The findings suggest that exchange rate volatility has a significant effect on exports of commodities under code 26 (ores), 38 (chemicals), 40 (rubber), and 47 (pulp paper) to India, Japan, South Korea, and the United States, either in the short or long-run. The exchange rate volatility of exports to China only affects plastics goods (code 39), although many goods experience negative effects due to exchange rate depreciation. In India, exchange rate volatility affects the largest number of export commodities. The Index of Industrial Production (IIP) has a strong long-term effect on exports to Asian countries. Impacts due to exchange rates offer both negative effects and positive effects (expected) in exports at commodity and trade partner case-to-case levels. Both aggregate ARDL and NARDL models suggest that Indonesian exports are negatively affected by exchange rate fluctuations.

Introduction

After the collapse of the Bretton Woods system, the impact of floating exchange rates on international trade has become an attractive object of research as the shift from fixed exchange rates exposed currencies to volatility, likely affecting trade flows. Although the exchange rate fluctuates typically beyond its fundamental condition, macroeconomic forces, market sentiment, global shocks, speculation, among others, could cause currency exchange rates to move beyond their underlying conditions. More recently, the interest has gained force as currency misalignments are seen as a source of global imbalances (Auboin and Ruta, 2013). Exchange rate volatility could potentially lead to market uncertainty, volatility in profits of traders, increase in risk, inflation uncertainty, unfavorable balance of trade, and impacts on production and transaction cost (Juhro and Phan, 2018). Economic theory proposes that exchange rate volatility is negatively associated with trade flows as changes in currency rates are linked to uncertainty (Clark, 1973), leading to changes in price expectations, and to potential changes in demand for goods (Clark et al., 2004) as traders aim to reduce risk exposure (Obstfeld and Rogoff, 1998). At the empirical level, a large body of research offers evidence on the discouragement of exports due to exchange rate fluctuations, supporting trade theory (Bahmani-Oskooee and Gelan, 2018; Chit et al., 2010; Hayakawa and Kimura, 2009). Nevertheless, some findings suggest positive or mixed effects of exchange rate volatility on exports (Chi and Cheng, 2016), while others find no evidence of impacts of volatility in exports (Nishimura and Hirayama, 2013).