Slow rockets and fast feathers Why exports fall fast but increase slowly after exchange rate changes

ANALYSIS

Gonzalo J. Varela

Slow rockets and fast feathers: Why exports fall fast appreciations) in the long run. A 10 percent real depreciation increases exports by 4.9 percent over a two-year period. Yet, and somehow validating that conventional wisdom, the speed at which exports adjust to the ‘new normal’ after a depreciation is only one-third as but increase slowly after exfast as the adjustment after an appreciation. Exports fall faster after (real) appreciations than they increase after depreciations. change rate changes The natural follow up question is why. We rely on product-destination level export data and examine three complementary explanations: information frictions, supply constraints, and pricing to

There’s no exportable surplus. market. First, information frictions increase the costs of finding new

That is the typical response you get from private sector and policy mak- clients and make losing clients after appreciations easier than getting ers alike when you ask why Pakistani exports don’t increase when the rupee new ones after depreciations. To test this hypothesis, we exploit the weakens. In other words, what Pakistan can export, it is already exporting. If fact that information frictions affect differentiated products more prices improve, then exporters will make more money, but will not expand than homogenous ones: finding a client to buy more t-shirts requires much. This reasoning is hard to accept, given that just a year ago we estimated agreeing on design, sizes, or pricing. Instead, if you are selling basmati the country’s export potential at US$88 billion—far more than it is currently rice, product specifications tend to be pre-defined and reference pricexporting. The “missing” export surplus is close to US$60 billion! es made public through organized exchanges. Our results back this

Understanding the extent of the export response to currency deprecia- up. For differentiated goods, export responses to depreciations are 27 tions is now more important than ever, as central banks in advanced economies percent lower than to appreciations, while there is no difference for are increasing interest rates to fight inflation. On June 15, the Fed increased homogenous goods. Thus, the value of export promotion in reducing rates by 75 basis points from 1 to 1.75 percent. Add to that, commodity prices the costs of searching for new clients increases after depreciations.are at record highs. The combination means that many developing economies Second, the “no exportable surplus” story is a supply conlike Pakistan face increasingly large import bills, scarcer external finance, and straints argument. If you were exporting recycled cotton towels and pressure on their currencies. Indeed, the PKR/USD parity hit a maximum of the rupee depreciated, you’d now get more rupees per towel. But scal210 on June 20, up from 185 only two months before. Flexible exchange rates ing up takes financing for that extra machine to recycle the yarn, and help weather external shocks, provided exports respond in a timely manner. the plant expansion. We examine the extent to which these supply

As economists, we are used to drawing an automatic link between (real) constraints explain the limited export response to depreciations, exchange rates and exports. If you export recycled cotton towels at $1 per exploiting differences in sectors’ access to credit. We find that an inpiece, the weakening rupee means 25 additional rupees per dollar exported crease in the credit-to-export ratio of 10 percent is associated with a 5 today than two months ago. Because a chunk of your costs is fixed in rupees – percent larger export sensitivity to the real exchange rate. Credit and say, the salaries of your workers, depreciations boost your profits, you’ll try to export responses to depreciations are complementary because credit sell as many towels as possible – perhaps hire a few additional workers to scale facilitates scaling up. But it’s possible that sectors that access more up, or even re-orient some of your domestic sales into export markets. credit are special for reasons other than credit, and that’s why they

We are also used to assuming a symmetric link. Exports increase with also respond faster to depreciations. This is why we also relied on (real) currency depreciations and fall with (real) appreciations in the same two largely exogenous export supply constraint variables: factor inway. But this may not always be the case. In a new paper with Martin Brun tensity and external finance dependence. We find that more labor-inand Juan Gambetta, we tackle this question of if and why export responses to tensive sectors and those that are structurally less external-finance real exchange depreciations are lower than those to appreciations. dependent show higher sensitivities to real exchange rate deprecia-

We first use macro-level data to understand the nature of the link tions. Taken together, these results point to supply constraints in imbetween exchange rates and exports in Pakistan. We find that, contrary to the peding export responses to depreciations. hird, we examine if pricing conventional (Pakistani) wisdom, exports do respond to depreciations (and to markets also explains the asymmetry. If Pakistani exporters are small relative to global buyers and have limited bargaining power, is a Senior buyers could negotiate lower dollar-prices after the rupee depreciates, thus eating up the exporters’ margins. This is Economist in the what Pakistani textile and apparel exporters told us when we interviewed them and asked them why they did not Macroeconomics, scale up exports after the depreciation of the rupee in 2018/19. Part of the benefit was passed to foreign buyers. We Trade and test this hypothesis by analyzing differences in exporting prices by selling destination. We find that adjustments in Investment Global profit margins stabilize export prices in the domestic currency, and this is amplified during depreciations: US dollar Practice of the World export prices react to nominal exchange rate changes by 15 percent more than in appreciations. This asymmetric Bank. He is currently response of export US dollar prices becomes more pronounced the larger the change in the exchange rate, suggestbased in Islamabad, ing that buyers smoothen prices in Pakistani rupees. While the focus of this analysis is Pakistan, it likely that these where he leads the results are also valid in other countries at a similar level of development. Policymakers should take stock of these trade program findings and ensure the enabling environment for a maximized export response to currency depreciations. Reproduced with permission from Trade Post