Export pricing strategies for firm-specific exchange rate shocks: pass on the cost, or swallow the bitter pill

Earlier literature states that during currency appreciation, exchange rate shocks will either be passed on to final export prices (exchange rate pass-through - ERPT) or be absorbed by producers via lower production markups (pricing-to-market - PTM). We construct an innovative model to examine how import intensity interacts with these channels and reduces the extent to which exchange rate shocks are passed on to the final prices. Using comprehensive Chinese firm-level export markup and firm-specific effective real exchange rate data, we find a lower ERPT after considering import intensity effects. This result indicates that the use of more foreign inputs does help to mitigate the increase in export price. We further compare different trade types. Evidence shows that processing firms have much smaller ERPT because they lower their markup to absorb the exchange rate cost during currency appreciation rather than passing such costs to end buyers. Moreover, being heavily reliant on imported intermediate inputs, processing firms can benefit from the lower cost of foreign inputs and further reduce their ERPT during currency appreciation.