Chinese exporters are more likely to change their prices in response to a change in the exchange rate than Indian exporters. That is the central finding of research by Sushanta Mallick and Helena Marques, presented at the Royal Economic Society’s 2013 annual conference.

The study looks at the extent to which changes in the exchange rate are reflected in changes in export prices – known as ‘exchange rate pass through’ (ERPT).

Comparing China and India, two of the world’s fastest growing exporters, the study finds that India’s exporters do not fully pass on changes when exporting to high-income markets. This is because they absorb changes in the Indian rupee by changing export prices in their own currency in the opposite direction to that of the exchange rate change. China’s exporters, on the other hand, change prices for all markets.

The authors argue that currency volatility and market power can explain much of this difference. Chinese exporters do not react so strongly to currency volatility given that they operate under a fixed exchange rate system with little volatility in the first place. India’s exporters experience much more volatility but some of them have the market power to set their own prices and change them as they see fit.

The pricing behaviour of exporters in China and India is particularly interesting to economists not only because of the growing role of these countries in the world economy but also because these two countries have followed very different exchange rate regimes: China has a fixed exchange rate regime whereas India has a flexible exchange rate regime.


The extent to which exchange rate fluctuations affect international prices (exchange-rate pass-through or ERPT) has been extensively studied, first for high-income countries and, in the last decade, also for emerging markets, such as India and China. The study of the pricing behaviour of exporters in these two countries has been motivated by the role of growth engines in the world economy taken up by emerging markets during the recent economic downturn.

The interest in the comparison between India and China is augmented by the fact that these two countries followed different options for integration in world value chains and maintained different exchange rate regimes. China has a fixed exchange rate regime and a great deal of outward processing trade, whereas India has a flexible exchange rate regime with predominantly arms-length trade.

The low degree of ERPT both at the disaggregated level and for aggregate price indices has been extensively documented by researchers. The explanations usually provided are primarily microeconomic and based on the existence of pricing to market (PTM) by imperfectly competitive firms.

This study starts out from that point of view, but introduces into the analysis a number of key elements that have been missing until now.

First, it is important to consider demand in the destination market along with demand in the exporting country, which can be crucial in the price-setting behaviour of an exporter. Until now there has been little focus on considering the role of demand-side factors of both exporting and importing countries in explaining price variation across markets.

In other words, PTM as a response to an exchange rate shock can be conditional on the size of demand in the exporting and importing countries, as measured by their per capita income. The degree of ERPT may also be correlated with the extent of outward processing trade that fosters transfer pricing. In general, transfer pricing can make the exporter’s price vary in the same direction as the exchange rate, amplifying exchange rate changes instead of dampening them.

Second, in the last decade the issue of firms with heterogeneous productivity has been introduced into the trade literature. According to that line of research, not all firms export and beyond that, not all firms export to all markets. Typically, only the highest productivity firms will export to high-income markets, whereas firms that are sufficiently productive to export but not enough to get into high-income markets may just export to low-income markets.

This selection effect may be associated with the kind of products they export; so the study incorporates the selection of firms in terms of product-market pairs. The researchers argue that the decision to stay in or out of an export market for a particular product may be correlated with the PTM decision. If this correlation exists but it is not taken into account, the ERPT estimates will be biased.

Third, there are significant differences in the variability of macroeconomic aggregates under fixed and flexible exchange rate regimes. Price discrimination causes ERPT to be incomplete in both the short and the long run with high exchange-rate volatility. Assessing the impact of exchange rate uncertainty or fluctuation on prices can help uncover the extent to which exporters in different countries respond to currency risks.

Intuitively, exporters may tend to trade more under an uncertain environment by adjusting prices so as to increase their current revenues when faced with an expected decline in future revenues. This suggests that we can expect either a positive or a negative effect of exchange rate uncertainty on export prices, depending on the source country and export market characteristics.

In this context, considering those two key emerging market exporters, where exchange rate fluctuations are respectively fully and partially managed by their monetary authorities, reveals whether exchange rate volatility tends to increase price discrimination and thereby reduce the degree of pass-through.

The study investigates these issues by comparing the extent of ERPT of the rupee and the yuan in response to changes in their NEER (Nominal Effective Exchange Rate).

First, ERPT is incomplete in India’s exports to high-income markets. There is full ERPT in the remaining cases. This is because Indian exporters absorb changes in the Indian rupee by changing export prices in their own currency in the opposite direction to that of the exchange rate change, but the opposite happens in the case of the Chinese yuan. The amplification effect of exchange rate changes into price changes in the case of China may be a sign of the existence of transfer pricing, which does not exist in the case of India.

Second, there is a selection bias in exports to high-income markets, where the decision to export to a certain product-market pair is correlated to the pricing decision. But the pricing of exports to low-income markets is independent of the decision to export.

Third, Indian exporters have changed their mark-ups in response to the rupee’s volatility, while Chinese exporters do not react to currency volatility given a fixed exchange rate system with a narrow band. This suggests that Indian exporters exercise market power to obtain price premia when their currency experiences volatility with respect to the importer’s currency.

There is a strong positive relationship between volatility and prices in the case of a (relatively) flexible currency system (India) implying low ERPT, while high ERPT occurs in the case of a fixed exchange rate regime (China).



Sushanta Mallick

Helena Marques

RES media consultant Romesh Vaitilingam:
+44 (0) 7768 661095

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