Exchange rate pass-through and importers’ credit constraints: Evidence from China

This paper examines the patterns of exchange rate pass-through (ERPT) into import prices among Chinese firms, and investigate the role played by credit constraints as well as sourcing diversity in shaping the degree of ERPT. Using highly dis-aggregated firm-product-country-level transaction data from 2000 to 2007, we find that (1) the average level of ERPT into import prices in China is around 73%; (2) for importers in financially more constrained sectors, ERPT tends to be more complete; (3) a higher extent of firms’ import sourcing diversity leads to a less complete pass-through and partially offsets the effects of credit constraints. Our findings provide convincing evidence of the significance of credit constraints in affecting ERPT into import prices. Furthermore, a more diversified import sourcing network can enhance the ability of importers to cope with exchange rate shocks and help alleviate the impact of financial constraints on exchange rate fluctuations. Finally, we provide theoretical explanations for the findings.