Working Paper - WP/12/08- Exchange Rate Pass-through to Import Prices, and Monetary Policy in South Africa

Understanding how import prices adjust to exchange rates helps anticipate inflation effects and monetary policy responses. This paper examines exchange rate pass-through to the monthly import price index in South Africa during 1980–2009. Various short-run pass-through estimates are calculated simply without recourse to a full structural model, yet without neglecting the long-run relationships between prices or the effects of previous import price changes, and controlling for domestic and foreign costs. Pass-through is incomplete at about 50 per cent within a year and 30 per cent in six months, averaging over the sample. Johansen analysis of a cointegrated system using impulse response functions broadly supports these short-run results, but as it includes feedback effects, implies lower pass-through for exchange rate shocks. This implies long-run pass-through of about 55 per cent compared to single-equation estimates of around 75 per cent. Shifts in pass-through with trade and capital account liberalisation in the 1990s are explored. There is evidence of slower pass-through under inflation targeting when account is taken of temporary shifts to foreign currency invoicing or increased hedging after large exchange rate shocks in the period. Furthermore, pass-through is found to decline with recent exchange rate volatility and there is evidence of asymmetry, with greater pass-through occurring for small appreciations.