SUBSTITUTION OF ANCHOR CURRENCY: CHALLENGES FOR TRADE BETWEEN IRAN AND ITS MAJOR TRADING PARTNERS

Abstract

The aim of the paper is to find out whether euro is a convenient substitution for U.S. dollar as an anchor currency for Iranian rial and whether this replacement would affect Iran’s international trade positively. We explore these effects via Optimum Currency Area (OCA) theories using generalized least square from 2000 to 2018. Based on OCA index, euro would be a good substitution for U.S. dollar as an anchor for Iranian rial. In addition, gravity model and Generalized Method of Moments estimation confirm that substitution of U.S. dollar by euro would improve bilateral trade between Iran and its major trade partners especially the European Economic and Monetary Union (EMU). Furthermore, we confirm that a basket containing main currencies (euro, U.S. dollar, yuan, Russian rubble) would be more efficient than a single currency anchor however euro should be prominent in the basket. Such a change of anchor could positively contribute to reduction of transaction costs, diversification of external risk, rise of mutual trade exchanges between Iran and the EMU or the EU and consequent economic growth of trade partners. The paper contributes to the existing literature by comprehensive methodological approach how to identify an appropriate anchor currency.