Do export quality and destination income matter for exchange rate pass-through? Evidence from China

Abstract

This study explores how export quality and destination income affect the degree of exchange rate pass-through (ERPT). While the literature has well documented various determinants of incomplete ERPT, we provide more insights by identifying factors from both supply and demand dimensions. Using Chinese export data over the 2002–2019 period, our empirical results indicate that export prices in home currency increase (decrease) with depreciation (appreciation) of the home currency. Chinese exporters tend to adopt a pricing-to-market (PTM) strategy, resulting in an incomplete ERPT rate of approximately 70%. Export quality and destination income are found to be crucial determinants. The ERPT is asymmetric to exchange rate movements and susceptible to uncertainties. Notably, the exporters subject to high additional duties still have PTM ability during the US–China trade war (2018). For China, these findings help explain the exchange rate disconnect puzzle and highlight the significance of adjusting the exchange rate policy.