Exchange Rate Pass‐through to China's Export Price: A Product‐level Investigation

• Date: 01 March 2016
• Author: Yanzhi Shen,Jian Han
• Published date: 01 March 2016
• DOI: http://doi.org/10.1111/cwe.12150

48 China & World Economy / 48–67, Vol. 24, No. 2, 2016

©2016 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Exchange Rate Pass-through to China’s Export Price:

A Product-level Investigation

Jian Han, Yanzhi Shen*

Abstract

Exchange rate movement usually results in changes in the production costs of exporting

firms, and, therefore, the prices and the quantity of traded products. The present paper

constructs a theoretical model to demonstrate that export products with higher productivity,

or with larger market share, or of higher quality will experience a less complete pass-

through. Using the six-digit harmonized system export data from the CEPII database over

the period of 2000 to 2013, the present paper examines how product heterogeneity affects the

exchange rate pass-through of Chinese exports. The empirical results show that the most

competitive Chinese export products, or those least affected by exchange rate risks, are

those of higher quality, with higher technological complexity and at the high end of the

international value chain. Therefore, Chinese exporting firms should pay more attention to

improving export quality and upgrading technology to better cope with exchange rate risks

and to enjoy more bargaining power in the international market.

Key words: exchange rate pass-through, export competitiveness, product heterogeneity

JEL codes: E31, F31, F32

I. Introduction

Over the past 30 years, China’s exchange rate regime has undergone significant changes,

from rigidly pegging the RMB to the US dollar in 1994 to allowing the currency to float

within a limited range in 2005. The nominal exchange rate of the RMB/USD had been fixed

at 1:8.28 for approximately 10 years before the reform. Although a fixed exchange rate may

have helped stabilize the Chinese economy, it also undermined the effectiveness of Chinese

monetary policy. In July 2005, China shifted its exchange rate regime to a managed floating

system based on market supply and demand. Afterwards, the RMB appreciated sharply

*Jian Han, Associate Professor, School of Economics, Nanjing University, Nanjing, China. Email:

hanj@nju.edu.cn; Yanzhi Shen (corresponding author), Assistant Professor, School of Economics, Nanjing

University, Nanjing, China. Email: yanzhi@nju.edu.cn. This research is supported by the National

Natural Science Foundation (Grant No. 71103083).

49

Exchange Rate Pass-through to China’s Export Price

©2016 Institute of World Economics and Politics, Chinese Academy of Social Sciences

against the US dollar, by almost 29 percent, to 6.41 as of December 2015. At the same time,

the economic volatility in Europe and Japan also resulted in large fluctuations of the

exchange rate between the RMB and their currencies. Both the nominal and real effective

exchange rate of the RMB experienced significant changes. From Figure 1, it is evident

that the RMB first depreciated by 11.5 percent by 2005 and then appreciated by almost

40 percent over the next 10 years. Although many scholars have argued that the RMB

appreciation would reduce the Chinese trade surplus (e.g. Bergsten, 2010; Krugman, 2010), it

still more than doubled from US$101bn in 2005 to US$235bn in 2014. 1 What is puzzling is that

when the RMB depreciated against the US dollar by 2.7 percent in 2014, Chinese exports were

not stimulated as expected; instead, they slowed down. These phenomena have spurred

research from the perspective of international economics, with the exchange rate pass-

through (ERPT) effect attracting considerable attention from scholars. Our study on

ERPT will shed light on these phenomena and help us to understand how Chinese firms

can adjust their production to better respond to exchange rate risks.

Exchange rate pass-through, also termed exchange rate elasticity, is the percentage

change in export or import prices resulting from exchange rate changes. The starting

theoretical point for examining the ERPT on export prices is the law of one price, which

posits that identical products must sell for the same currency price in different countries

Figure 1. Change in Nominal and Real Effective Real Exchange Rates of RMB, 2000–2015

70

80

90

100

110

120

130

140

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Effective exchange rate

Year

Nominal

Real

Source: Data from Bank for International Settlement website, available from: http://www.bis.org/.

1These figures come from the website of the National Bureau of Statistics of China: http://www.stats.gov.

cn/english/.