Do exchange rate changes pass-through into inflation in developing countries (with particular reference to India)?

Exchange rate pass-through (ERPT) refers to the transmission of exchange rate changes into import (export) prices of specific goods, measured in terms of the destination market currency. ERPT is said to be ‘partial’ or ‘incomplete’ if the import price rises by less than one per cent, as the exporters absorb a portion of the exchange rate change. The issue of ERPT is particularly important in view of its policy implications for small and open economies. Specifically, if ERPT is low, use of any exchange rate based adjustments to improve the trade balance for these economies may be rendered less effective, an issue that has been of some concern in the case of the persistent United States (US) trade deficit despite secular declines in the US Dollar (US$). ¹ Conversely, low ERPT implies that small and open economies may be less concerned about the potential inflationary consequences of exchange rate fluctuations. ² A closely related term is pricing-to-market (PTM), which refers to the pricing behaviour of firms exporting their products to a destination market following an exchange rate change. Formally, PTM is defined as the per cent change in prices in the exporter’s currency due to a one per cent change in the exchange rate. Thus, the greater the degree of PTM the lower is the extent of ERPT (Dornbusch 1987; Krugman 1987; see also the surveys by Goldberg and Knetter 1997 and Menon 1995).