How Does the Economy Respond to a Depreciation? Evidence in the Dynamics of Profit Margins, Company Values and Retail Prices of Mexican Public Corporations, 2010-2017

This paper compares the effect of exchange rate variations during 2014-2017 on industries that differ across their real exchange rate exposure and across the intensity of competition that they face, using price data as well as accounting, financial market, and customs data on 56 Mexican public corporations. Among the firms with greater export activity, those that are in industries with more intensity of competition show a strong relationship between the exchange rate and profit margins, specially early in the sample. In contrast, a depreciation leads to a reduction in profit margins, and relative stock prices of firms without little or no export activity. However, these effects are concentrated on firms with high profit margins and moderate competition, so that the overall effect on profit margins of non-exportign firms is small. The results are more consistent with the Dornbusch (1987) model of trade and intensity of competition than with two alternative models. In our interpretation, besides the traditional input cost pass-through channel, an important mechanism by which a depreciation afected relative prices is through the reduction in competition faced by local firms in exporting industries; in addition, there is evidence that the relative price change was accompanied by a reduction in the relative demand for non-tradable goods and services and for imported goods. Finally, the results suggest that, from 2014 to 2016, the peso depreciation led to a relative price adjustment that was complete by 2016Q4, without having affected headline inflation, and that there was no evidence of “latent” pass-through to inflation at that time or later on.