Exchange rate pass-through and invoicing currency choice between fixed and floating exchange rate regimes: Evidence from Malawi’s transaction-level data

Abstract

We document comparative evidence on invoicing currency and exchange rate passthrough (ERPT) before and after an importer has switched from a de facto peg to a floating exchange rate regime. Our study utilizes customs data of Malawian imports from across the globe, at Harmonized System (HS) 8-digit level. We demonstrate that: (1) the share of U.S. dollar invoicing increased by 9.4 percent and exchange rate passthrough also increased after the regime switch; (2) a fixed exchange rate regime limits pass-through of the bilateral exchange rate by about 20 percentage points. (3) When invoicing currency is considered however, we find that this difference in the regimes holds and ultimately, the difference in the pass-through of the two regimes is explained solely by the dollar exchange rate. However, the USD exchange rate is in itself not particularly larger than the ERPT of other currencies such as the euro and the South African rand. Given that flexible regimes are usually associated with a greater ability to absorb real external shocks in a small open economy, the policy implication is to for monetary policy to consider these heterogeneities when considering the exchange rate risk and impact on domestic prices in developing countries like Malawi, and to promote competitive market structures in developing countries.