Exchange rate volatility and import of intermediate inputs: Evidence from Chinese firms

Abstract

An extensive amount of literature suggests that exchange rate volatility has a negative impact on international trade. However, very few research consider the distinct effect of exchange rate volatility on intermediate input trade. This paper studies the effects of exchange rate volatility on the import of intermediate inputs and evaluates how the effects are shaped by a series of firm characteristics. Using a comprehensive dataset of Chinese importing firms from 2000 to 2006, our empirical analysis indicates that exchange rate volatility negatively impacts the import of intermediate inputs both on the extensive and intensive margin. Further, we find that this negative effect is more pronounced for firms with higher financial vulnerability. We use a simple schematic diagram to explain the transmission mechanism and emphasize the role of financial vulnerability in amplifying the effects of exchange rate volatility.